Hello, I have a question regarding the risks considered in valuing private equity. When we value a private firm using the Free Cash Flow method, we may forecast future cash flows for several scenarios and discount them using the adequate rate. The firm risk is included in the discount rate as a premium applied to the required return on equity: equity risk premium and firm-specific risk premium. But we then value the firm as a weighted mean of the value from each scenario, one of them even being “bankruptcy” in the example. So isn’t the firm risk accounted twice in that case : in the required return and in the scenarios (and especially the bankruptcy scenario)? Some details on the risk embedded in the firm specific premium would also be appreciated, i don’t really get what it covers exactly. Thank you in advance
Anyone?
I think not. The required return includes a premium for the uncertainty of the returns, but not (explicitly) for the level of the returns; the scenarios provide the level of returns, but not the uncertainty of returns.