Valuation / discount rate question

Water Cooler Investing
#1

Hello guys,

Quick question on valuation - say I have a mature company, about 20 years old, that never had any debt in its structure and is now being valued for a sell-side mandate. Industry-wise the D:E is close to 50%. How do you approach the disc rate in this case? Cost of equity for the 5 year horizon and then wacc @ industry levels at terminal value? (Then again terminal CF is unlevered:) )

Any ideas?

Thanks a lot and stay safe.

#2

I would assume an acquisition is financed by a buyer at a similar cap structure to the industry (assuming reasonable debt coverage ratios and debt to EBITDA ratios) and use that for your WACC calculation. Or you could use an LBO model (FCFE) and factor the leverage in that way.

1 Like
#3

Thank you :clap: - I was thinking the same re WACC, ie using industry ratios; but my question is:

  • Debt-free projections, cost of equity for the horizon and adjusted WACC for the terminal value?

  • Debt-free projections and adjusted WACC throughout i.e. horizon and terminal value? or,

  • Model debt in the projections, possibly converging to industry by terminal year and WACC throughout?

#4

Of the options, this is the one I would choose and is consistent with how most business valuation professionals would value a company.

If you are looking at a sell-side engagement an LBO model that assumes debt in the acquisition financing might also be appropriate.