Reading 44: Private Company Valuation-LOS f 习题精选 2010, including, valuation, private, company

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

LOS f: Demonstrate the methods under the income approach to private company valuation, including the free cash flow method, capitalized cash flow method, and excess earnings method.

 

 

 

The capitalized cash flow method (CCM) used in private firm valuation is most appropriate when:

A) there are many intangible assets to value.

B) earnings are growing quickly in an initial period.

C) stable growth is expected.

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The CCM is a growing perpetuity model that assumes stable growth and is in effect a single-stage free cash flow model. It may be suitable when no comparables or projections are available and when stable growth is expected. The excess earnings method (EEM) is useful when there are intangible assets to value. The free cash flow method assumes high growth in an initial period followed by constant growth thereafter.

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Using the following figures, calculate the value of the equity using the capitalized cash flow method (CCM), assuming the firm will be acquired.

Normalized FCFE in current year	$3,000,000
Reported FCFE in current year	$2,400,000
Growth rate of FCFE	7.0%
Equity discount rate	16.0%
WACC	13.0%
Risk-free rate	3.5%
Cost of debt	10.5%
Market value of debt	$3,000,000

The value of the equity is:

A) $35,666,667.

B) $28,533,333.

C) $32,666,667.

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To arrive at the value of the equity using the CCM, it can be estimated using the free cash flows to equity and the required return on equity (r):

Note that we grow the FCFE at the growth rate because the current year FCFE is provided in the problem (not next year’s FCFE). We use normalized earnings, not reported earnings, given that normalized earnings are most relevant for the acquirers of the firm. The relevant required return for FCFE is the equity discount rate, not the WACC.

An alternative approach to calculate the value of the equity would be to subtract the market value of the firm’s debt from total firm value. However, the FCFF are not provided so a total firm value cannot be calculated.