DCF problem
Hey everyone,
I'm doing (for the first time) an M&A project through my university and am a little worried about my DCF model. For the project we have to do both an FCFE and FCFF valuation.
I've made all my assumptions and plugged all my numbers in, and the result was an extremely similar value per share under both models. However, in neither model could I find an application for the target gearing ratio given to us for the valuation. So my question is: where does the firm's target gearing come into play in a DCF model?
Thanks in advance
Information given to us is below
FCFE = EBIT - Tax - Change in working capital - Capex + Depreciation
FCFF = NPAT - change in working capital(1-debt ratio) - capex(1-debt ratio) + depreciation*(1-debt ratio)
Terminal value = ( final cashflow * (1+g) ) / (WACC - g) (where g is perpetual growth rate)
Given values to assume:
equity market risk premium 6% risk free rate 6% cost of debt 7% Company X beta 1.30 target gearing 40% corporate tax rate 30%
WACC calculation.
Hmmm. If you use it in the WACC, would you then also use it in the debt ratio? As opposed to the actual gearing/debt ratio from the statements?
When forecasting FCFE, you assume that the firm will maintain a target debt/asset ratio in any net new fixed investments and working capital.
WACC=Kd(1-tax rate)target gearing +Ke(1-target gearing) =7%(1-30%)40%+(6%+1.36%)(1-40%)=10.24% use the WACC to discount the cashflow
For a company with a steady capital structure you have to use the WACC (as stated above), however if a companys' capital structure fluctuates you can better use the APV method
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