8. Private Company Valuation Flashcards
Which are the main differences between the methods of CAPM, expanded CAPM and build-up in calculation of Ke.
CAPM
ke = Rf+Beta*(Rm-Rf)
Expanded CAPM
Add ‘small stock premium’ and ‘company-specific risk premium’.
Build-up method
Omitt beta but add industry risk premium to Expanded version.
How to make control premium adjustments?
Control premium adjustments are made only to the equity portion of the firm’s value. There are two ways to incorporate control premium under a guideline public company method:
1) Use the raw multiple to estimate firm value (without control premium) and estimate the equity portion (by subtracting debt). Apply the control premium to the equity portion as estimated.
2) Beginning with an equity control premium, we adjust this control premium for valuation using an Market Value of Invested Capital (MVIC) multiple:
Adjusted Control Premium = (control premium on equity) * (1-DR)
DR: Debt-to-asset ratio
Explain how to determine Discount For Lack of Control.
The factors for determining a discount for lack of control are the same as those for the control premium. Because it is difficult to measure the disadvantage from a lack of control, the discount is usually backed out of the control premium:
DLOC = 1 - 1/(1+control premium)
When Discount for Lack of Control and Control Premium would be used? Give an example for each.
When the Guideline Transactions Method is used for valuing a noncontrolling interest. DLOC should be used. Recall that in the GTM, the comparable price multiple data is for the sale of entire firms where control is acquired.
When Guideline Public Company Method is used for valuing a controlling interest, Control Premium should be used. Recall that in the GPCM, the comparable price multiple data is from noncontrolling interests.
Explain Discount for Lack of Marketability.
If an interest in a firm cannot be easily sold, discounts for lack of marketability (DLOM) would be applied (sometimes termed a discount for lack of liquidity). It is often the case that if a DLOC is applied, a DLOM will also be applied. To estimate the DLOM, an analyst can use one of three methods.
In the first, the price of restircted shares is used. As an example, SEC Rule 144 may restrict the sale of shares acquired in a firm prior its IPO. In this case, the price of the restricted shares is compared to the price of the publicly traded shares.
In the second method, the price of pre-IPO shares is compared to that of post-IPO shares. One complicating factor is that post-IPO firms are generally throught to have more certain cash flows and lower risk, so the estimated DLOM may not purely reflect changes in marketability.
A third method would estimate the DLOM as the price of a put option divided by the stock price, where the put used is at-the-money. The time to maturity of the valued option could be the time to the IPO. The volatility used could be based on the historical volatility of publicly traded stock or the implied volatility of publicly traded options. The advantage of this approach over the other two is that the estimated risk of the firm can be factored into the option price.The drawback of this approach is that a put provides a certain selling price, not actual liquidity.
Although these methods provide a baseis for calculating DLOM, it is often challeging to implement them.
DLOC and DLOM are multiplicative or additive?
Multiplicative.
Total Discount = 1 - [(1-DLOC)*(1-DLOM)]
