DCF result - Equity value from EV
Hi all
What is the correct way to arrive at equity value after the EV was calculated (via DCF)? Suppose we have to value equity of a PRIVATE company. We identified target cap. structure, performed DCF and got the EV. What to do next?
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subtract debt which is taken from the BS (assumption that book value of debt = market value) from the EV figure
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Apply weights used in WACC to the EV figure.
These 2 options would normally produce different results. Using the first approach would contradict the cap. structure built into WACC. With the 2nd approach, Debt from the BS will differ from the Debt resulted from multiplying weight of Debt from WACC with EV figure.
You always subtract debt / NCIs and add back cash to get to Equity Value in the DCF.
However, the debt / NCI / cash balances you use depend on your valuation date. Normally if the valuation date is in the future (i.e. sometimes you use the illustrative transaction close date), you would have an operating model to project out balances on the valuation date. This would capture your company levering up / delevering to hit their long-term cap structure. If your valuation date is today, it's fine to use current balances, as long as what's happening with your projections reconcile with how the company is achieving their long-term cap structure.
Conceptually the correct way to do the DCF would be to have the WACC move as the company changes their capital structure, but realistically most of your value is coming from the terminal value, so using a WACC derived from target capital structure for Y1 / Y2 cash flows is fine.
Thanks for the comment. Was a bit confused when saw an example where the EV was multiplied with the weight from WACC to arrive to equity value. In my opinion this might be correct in theory in case the current capital structure of the company already matches with the long-term steady state one. Which is rarely true I guess.
Unless there is a significant expected change in capital structure, you would usually use the current capital structure to calculate WACC. If there’s a path to a target structure, then your operating model should reflect that path, and thus you should still use the balances on your valuation date. I.e. if you want to value the company after an acquisition you may use target capital structure, but I’ve never seen this done in practice.
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