Reading 44: Private Company Valuation-LOS h 习题精选 class, div, contrast, required, discuss

土豆妮

Session 12: Equity Investments: Valuation Models
Reading 44: Private Company Valuation

LOS h: Compare and contrast models used to estimate the required rate of return to private company equity (e.g., the CAPM, the expanded CAPM, and the build-up method), and discuss the issues related to using each.

 

 

 

Using the following information, calculate the required return on equity using the expanded CAPM.

Income return on bonds	6.0%
Capital return on bonds	2.0%
Long-term Treasury yield	3.5%
Beta	1.4
Equity risk premium	6.0%
Small stock premium	4.0%
Company-specific risk premium	3.0%
Industry risk-premium	2.0%
Pretax cost of debt	11.0%
Optimal Debt/Total Cap	16%
Current Debt/Total	7%
Debt/Total Cap for public firms in industry	33%
Tax Rate	30%

A) 18.9%.

B) 15.9%.

C) 11.9%.

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The required return on equity using the CAPM is: 3.5% + 1.4(6%) = 11.9%.

Note that the risk-free rate is the Treasury yield, not the returns for bonds in general.

Using the expanded CAPM, a small stock premium and company-specific risk premium are added: 11.9% + 4% + 3% = 18.9%.

土豆妮

Using the following information, calculate the WACC using the build-up method, assuming the firm is being acquired.

Income return on bonds	6.0%
Capital return on bonds	2.0%
Long-term Treasury yield	3.5%
Beta	1.4
Equity risk premium	6.0%
Small stock premium	4.0%
Company-specific risk premium	3.0%
Industry risk-premium	2.0%
Pretax cost of debt	11.0%
Optimal Debt/Total Cap	20%
Current Debt/Total	7%
Debt/Total Cap for public firms in industry	33%
Tax Rate	30%

A) 17.7%.

B) 18.5%.

C) 16.3%.

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Using the build-up method: the risk-free rate, the equity risk premium, the small stock premium, a company-specific risk premium, and an industry risk premium are added together: 3.5% + 6.0% + 4.0% + 3.0% + 2.0% = 18.5%. Note that the risk-free rate is the Treasury yield, not the returns for bonds in general.

Because the firm is being acquired, we assume the new owners will utilize an optimal capital structure and weights in the WACC calculation. The capital structure for public firms should not be used because public firms have better access to debt financing.

The WACC using the optimal capital structure factors in the debt to total cap, the cost of debt, the tax rate, and the given cost of equity:

[20% × 11% × (1-30%)] + [(1-20%) × 18.5%] = 16.3%.

土豆妮

Which of the following best describes the build-up method used for the estimation of the discount rate in private company valuations?

A) Because it is not used in the calculation, beta is assumed to be zero.

B) An industry risk premium is not included because it is captured in the equity risk premium.

C) It is useful when there are no comparable public firms.

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If it is not possible to find comparable public firms with which to estimate beta by, the build-up method can be used for a private firm. It is similar to the expanded CAPM except that beta is not used. Implicitly, beta is assumed to be one. Both industry risk premiums and equity risk premiums are used. The risk-free rate, the equity risk premium, the small stock premium, a company-specific risk premium, and an industry risk premium are added together in the build-up method.