Hi, I am seeking a clarification here. In a FCFE valuation, should we discount the FCFE by cost of equity of the target company or the cost of equity of the financial sponsor(i.e. target equity retrun) to obtain the equity value that the financial sponsor shall pay?
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Thanks! Do you mean that financial sponsor will use a lbo model to determine whether the equity price (as an input) can deliver a target return?
COE = Sponsor's target IRR for two reasons: i) existing shareholders are all wiped out in an LBO so the only cost of equity is the remaining investor's (sponsor's) required rate of return and ii) this model is being built from the perspective of the sponsor who would be more concerned with seeing how much he can pay for a company given his required rate of return (target IRR) not what existing shareholders are demanding. But I agree that FCFE DCFs aren't the typical way of backing out a purchase price for the purpose of an LBO - more common to reverse engineer the LBO and back out purchase price using a given IRR. FCFE DCFs are typically used by sponsors to value an existing portfolio company for reporting to LP purposes
bro you're a genius. respects.
Thanks for this. But what is LP?
limited partner, so just an investor in the manager's fund
DCF is completely useless as the capital structure won't stay the same in an LBO. You could try APV.
WACC / CoE calc always done relative to the company being valued (so use target cost of equity).
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