WACC formula?
Okay so I got this interview question : When you use WACC for a DCF model you have E+D+P in your WACC formula, but isn't it EV already? When you do a DCF you are calculating its EV, which you already have in your WACC formula. You are using EV to calculate EV. Isn't it a circular? and how do you solve this problem?
(EV = Enterprise Value, E= equity value, D=Debt value, P=Preferred Stock value, E,D,P all taken as market value instead of book value)
I thought when doing a DCF you are valuing company based own YOUR assumption of future cash flow, and assumptions are based on public (and E+D+P here) or private information. So I thought it was okay just to simply put market value of E+D+P when calculating WACC
But the interviewer said something about looking at trading comps and somehow factor it in when you are putting in E into the WACC formula etc (due to poor reception I didn't get his answer clearly) and now I am a bit confused....never came across that in any interview, or any textbook.
Do you use trading comps when calculating equity value part of the WACC? ( I thought you just simply take the market cap)
The WACC formula provides a discount rate to use on your FCF to derive the Enterprise Value (not EV if you are assuming equity value).
And what part of the WACC formula has equity value in it?
WACC = Return on equityy {given by CAPM} * E / E+D + return on debt * D/ E+D * (1-t)
Equity Value = Price per share * fully diluted shares outstanding
Enterprise value = Equity Value + minority interest + preferred stock + Net Debt (Debt-cash)
I don't know if that answers your question, but your post bounces all over the place.
The WACC formula provides a discount rate to use on your FCF to derive the Enterprise Value (not EV if you are assuming equity value).
And what part of the WACC formula has equity value in it?
WACC = cost of equity {given by CAPM} * E / E+D + cost of debt * D/ E+D * (1-t)
Equity Value = Price per share * fully diluted shares outstanding
Enterprise value = Equity Value + minority interest + preferred stock + Net Debt (Debt-cash)
I don't know if that answers your question, but your post bounces all over the place
You should probably get a banker to chime in to see how it is done in the real world, h/w WACC is just the rate you use to discount FCF -- it is a weighted average based on the firm's capital structure. If you are discounting unlevered FCF and a terminal value, you are deriving an enterprise value for the company.
Equity value is just the market cap alternatively you could subtract net debt and minority interest from EV to get to equity value. EV=equity value + net debt + minority interest. So Equity value = EV-ND-MI.
You use comps to find an average beta which you unlever and then relever using the firm's capital structure for the CAPM model, if the company does not not trade. Buy the WSO guide if you have not seen this.
Sorry I'm not stating this clearly, I know the formula of WACC = (Equity value/(Equity value + Debt Value + Preferred Stock Value) * Cost of Equity) + (Debt value/(Equity value + Debt Value + Preferred Stock Value) * Cost of Debt) + (Preferred Stock value/(Equity value + Debt Value + Preferred Stock Value) * Cost of Preferred Stock)
Yes you need to unlever beta (of comparable companies) and relever it based on its own capital structure, when calculating Cost of Equity
But the interviewer was asking "special treatment" of Equity value part ( Equity value/(Equity value + Debt Value + Preferred Stock Value) ) cuz I usually just directly take its market cap (which is its Equity value)
What "special treatment" you need to do with Equity Value that involves trading comps? That's where I got lost
Hope I made this clear
anyone knows the answer?
The interviewer was probably asking about equity value for private companies. I'm not a banker, but I'm doing the same analysis in a restructuring course right now.
For private companies, we don't have a stock price so one can use the implied equity value from trading multiples.
Yeah, but can't you just subtract net debt from enterprise value to get to equity value.
But to get enterprise value you need equity value, so you are running in loops again.
If you discount the future value of un-levered free cash flow, you are deriving the enterprise value of a firm; subtract net debt, and you've equity value.
yea, but what discount rate are you using? you need to use WACC and to get it you need Equity value/ total capitalization. so you need to find equity value first.
there are multiple ways of doing it. check out the pdf from Stern - http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/pvt.pdf
The method I proposed is taking market value of long-term debt (if available), and using an implied equity value from trading multiples. Assuming no preferred stock, the sum of debt and equity are your total capitalization (V).
From there you get your weights for the private company: E / V and D / V. Using the weights, you calculate WACC, and proceed with your DCF analysis.
The pdf from Stern says to be consistent in your approach, so not sure if one should use implied Debt from multiples as well to be consistent with the implied Equity value from multiples. However, I would argue to use known debt value if it's available and implied equity value, since it'll provide a better picture of real capitalization.
Again, I don't do this for work, so hopefully someone from the industry can add color.
When he was saying "Special treatment", he was clearly looking for you to say CAPM and then walk him through the CAPM formula. CAPM is the cost of equity, the only thing you should ever use trading comps for is to select EBITDA multiples, possibly margins going forward if mngmt. only provides top line growth. Get a fucking grip people.
Please explain what CAPM has to do with equity value when equity value = stock price * common shares outstanding?
Or, HF, are you saying for a private company one should get FCFE and discount by cost of equity to get the present value of equity?
By using a DCF you are automatically not taking into account the market cap. as your equity value number. Equity value is derived from the DCF, this is used to get a valuation for non public companies who don't simply have an easy share price * shares outstanding calc.
Or for public companies it could be used to arrive at a bid price for an acquisition or to see if a merger will be dilutive or not. By getting your Equity value through the DCF, you are able to arrive at a share price you think should be offered to the company for an acquisition. Any asshole can calculate the EV using share price * shares outstanding + net debt + minority interest, the IB's job is to help analyze and see if there is an opportunity for a gain, the bid price and outcome of the acquisition is only as good as the inputs used ie. public comps selected, anticipated growth, margins, and other subjective info.
Yes, I agree with you HF; however, when you say "using a DCF"....how do you get your WACC?
Assuming no pref. shares....you would get your WACC as follows: WACC = cost of equity * weight of equity + after-tax cost of debt * weight of debt
So, how do you go about getting your weight of equity for a private company? (this is the question I posted my opinion on up above.)
cost of equity= risk free rate + beta (market risk premium)
guess i didnt see the private company tidbit but if it's private you will need to use comps to get a beta.
yes, i agree with you on using comps for beta (when a private company) and cost of equity using CAPM.
but, again, how do you get your weight of equity to total capitalization?
market cap* current share price.... it is not a circular reference since you are only using this to derive WACC. Once WACC is calculated you are looking for the total equity value through your DCF, dividing by shares to get at your new price. You are thinking about this way to complex, you get your weight of equity, debt, and preferred throught the market. Derive your WACC, EBITDA multiples, and FCF to get to anticipated equity value. Now divide this by fully diluted shares outstanding (after using the trasurey method for accounting for shares and convertible debt/preferred that are in the money). No circular references, do a WSP, or TTS practice model if you haven't had real experience and it will become very clear.
Ah, but there in lies the problem HF.
We can't do market cap * current share price if the target company is PRIVATE. So how do you account for this?
Now you finally get the question I posted an answer to earlier...
Ahh sorry, should have probably read the posts. equity value is usually taken from the last round of financing because that is the most accurate perception of the markets value for the equity value. Pretty ridiculous question if someone has no PE experience.
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