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 (FCFF/FCFE)
Can be particularly challenging for a private firm challenging given the figures depend a lot on current owners’ input.

Consider several scenarios:
• Development stage firms scenarios could include a sale of the firm, an IPO, bankruptcy, or continued private operation.
• Mature firm stage scenarios might do include multistage based on different assumed growth rates.

For each scenario, do simulation:
• assign a discount rate and probability, find value repeatedly and get weighted average of these values; or
• 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 FCFE when the significant changes in the firm’s capital structure are anticipated (as in AG we just saw –
too low leverage) as WACC is less sensitive to leverage changes than the cost of equity!

EXAMPLE: Estimation of FCFF:

An analyst has normalized the earnings and expenses for a private firm under consideration as an acquisition.
Because the capital structure is non-optimal, the analyst assumes that the capital structure will be changed if
the firm is acquired and will use the FCFF approach to value the firm.

The following assumptions are used to create a pro forma income statement and to estimate FCFF.