Page 48 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 33.g: Explain factors that require
adjustment when estimating the discount rate READING 33: PRIVATE COMPANYVALUATION
for private companies.
MODULE 33.2: INCOME-BASED VALUATION

Size premiums: Using small public firm data may be biased upward as many in the sample may be experiencing financial distress.

Availability and cost of debt: They have higher operating risk, hence higher cost of debt as well, WACC will typically be higher!

Acquirer versus target WACC: Some acquirers incorrectly use their own (lower) WACC, rather than the higher rate appropriate for the target.

Projection risk: Due to lower availability of information and managers inexperienced at forecasting, increase the discount rate!

Lifecycle stage: Although ranges of discount rates can be specified for the various lifecycle stages, it is hard to classify the stage a firm is in.

LOS 33.h: Compare models used to estimate the required rate of return to private company equity (for example, the
CAPM, the expanded CAPM, and the build-up approach).

CAPM: Typically, beta is estimated from public firm data, but be inappropriate for private firms that have little chance of going
public or being acquired by a public firm. Some U.S. tax courts have rejected the use of the CAPM for private firms.

Expanded CAPM: Fama and French! Includes additional premiums for size and firm-specific (unsystematic) risk.

Build-up method: Used when it is not possible to find comparable public firms for beta estimation. Beginning with the expected
return on the market (beta assumed to be one), premiums are added for small size, industry factors, and company specific
factors.