Page 44 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 33.e: Explain cash flow estimation issues READING 33: PRIVATE COMPANYVALUATION
related to private companies and adjustments
required to estimate normalized earnings.
MODULE 33.2: INCOME-BASED VALUATION

Estimating Cash Flow
Calculating FCFF or FCFE for private firms can be particularly challenging given uncertain future cash flows and figures that are
often generated using the current owners’ input.

When there is significant uncertainty about a private company’s future operations, the analyst should examine several scenarios
when estimating future cash flows:
• Development stage firms, scenarios could include a sale of the firm, an IPO, bankruptcy, or continued private operation.
• Mature firm, scenarios might include different ranges of cash flows based on different assumed growth rates.

For each scenario, assign a discount rate and probability based on the scenario’s risk and probability of occurring. A firm value
for each scenario is estimated, and a weighted average of these values is used to estimate firm value. Alternatively, a weighted
average scenario cash flow may be discounted using a single discount rate to arrive at an estimate of firm value.

FCFF is better than FCCE when the significant changes in the firm’s capital structure are anticipated. The reasoning is that the
discount rate used for FCFF valuation, the weighted average cost of capital (WACC), is less sensitive to leverage changes than
the cost of equity, the discount rate used for FCFE valuation.