Question #47
Reading: Reading 24 Private Company Valuation
PDF File: Reading 24 Private Company Valuation.pdf
Page: 23
Status: Correct
Correct Answer: A
Question
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:
Answer Choices:
A. $35,666,667
B. $32,666,667
C. $28,533,333
Explanation
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.
(Module 24.3, LOS 24.h)
value of equity =
FCFE1
r −g
value of equity =
= $35,666,667
$3,000,000 × (1.07)
0.16 −0.07