Anyone know how to find or can link me to some info about calculating WACC for a private firm? Specifically, the market value of the firm is what I don’t know how to calculate and thus can’t feed the equation.
You have two options: 1. Assume a target D/E ratio as predicted by management. Then Debt/Capital = D/E / {1+ D/E} OR… 2. Use an industry average D/E ratio from public comps. This approach is much better especially if the company is likely to go public in the future. Typically, industry average D/E ratio’s are very close to their optimal levels- where firm value is maximized. The choice is really yours, depending on the premise of your valuation.
Instead of WACC to value the private firm, follow these steps: 1) Find about 8-10 comparables (public companies) (pure plays, if possible) and find the levered betas. Unlever these betas and average them to get an unlevered beta for the business. This is the market risk of the business. 2) Use CAPM to find the return on assets, R(A) 3) Use this R(A), to discount the cash flows to the firm. This will give you the all-equity (assuming no debt) value of the firm. Please note that the actual value of the firm will be slightly higher than this since we have ignored the present value of the interest tax shields PV(ITS). Typically this is a small component of the total firm value ( about 10%). You may use this number as a first approximation to calculate WACC. 4) Else, you may make an estimation of the long term Debt to Total Capital ratio. You may ask the investors/owners if they have a target ratio in mind. If they have one, use that. Else, you may take the average industry debt to capital ratios (from the comparables) as a good first approximation. Then WACC = R(A) - t[D/(D+E)] R(D), t=marginal tax rate Please note that I have assumed that you are valuing the firm from the point of view of a diversified investor. If you are a private equity firm trying to value a private company whose owner has all (or substantially) his wealth tied in the company, then asset betas may have to be tweaked to incorporate the total risk (as opposed to just market risk). Also, plaese note that WACC is used to discount cash flows to firm only when you assume that the Debt to Total Capital ratio remains constant in future. Hope this makes sense.
Thanks guys. Part of the problem is that it’s a small company (3-4mil revenue) with no debt, and the acquiring business is planning purchasing with cash or an earn out. I’m modeling for them and I want to include some valuation numbers as well. They really only want an extended earnings model, but since I’m studying for the CFA and I’ve gone over some IBanking model courses I’m attempting ot test out my knowledge real hand on this small project. Also, where is the best place to look for public comps?
Greenman: Valuation practitioners sometimes use what is called an iterative approach to value private companies. This is basically where you begin by assuming a certain capital structure, calculate the value of the firm based on this capital structure, and then see if the resulting value of the firm is equivalent to the initial capital structure that you assumed. When the initial and resulting capital structures are equal, then you have found the WACC. This sounds a bit complicated, but you can do it quickly in Excel. However in this case, since this valuation is for purposes of an acquisition, it might make sense to value the firm being acquired using the capital structure of the acquirer, especially if it will be incorporated into the business. If this is a private equity deal, then I would simply use an industry or “optimal” WACC based on market comps. Good luck.