Perpetuity Growth & WACC for Private Small Business
How would you determine the appropriate perpetuity growth rate and cost of capital to use for a private small business? Really appreciate the help
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For WACC, you could just look at what it is for public comparables and use that. If the private company has registered debt securities, then you have the (after tax cost of debt * % of debt in capital structure) term for WACC. Then, you'd only need to find levered beta for the private company to get the equity term portion of WACC. To do this, you'd find levered betas for public comparables and unlever them. Then, you'd take the average or median of the unlevered betas and then relever this to private's capital structure. You can easily calculate WACC now because you have cost of debt and cost of equity and the proportions of each in capital structure.
Typically, the perpetuity growth rate is usually around 2-4% because it picks an economic anchor such as inflation or nominal GDP growth. Usually, this method is more so of a sanity check to see if the implied growth rate, based off the exit multiple, is realistic. It's not really used to determine the terminal value unless there's no relevant public comparables. To answer your question, usually you'd do a sensitivity analysis with a smaller range of growth rates from in between 2-4%. For the exit multiple, you'd look at LTM trading multiples for public comparables.
Hope this helps
This was great help. Thank you very much. I just have one question. So when comping up with the implied enterprise value, you would rely on the exit multiple rather than perpetuity growth? I thought you would show both with the two different implied EVs that come from the perpetuity growth and exit multiple
I don't want to say always, but yes, most of the time you are going to base your implied EV off the exit multiple. If there aren't relevant comparable public companies, then you might resort to the perpetuity growth method. The reason why perpetuity growth method isn't often used for the valuation range(as determined by a DCF) of implied EV is because it's unrealistic. Think about what the PGM implies. It assumes the company will generate cash flows forever and never stop operating. When would that ever be true in real life? Almost all companies have a fixed lifespan and eventually stop operating, even the best ones.
Like I said before, it's mostly used as a sanity check. You would use an exit multiple and then determine the terminal value. Then you'd set this terminal value equal to what the terminal value for the PGM formula would be(input FCF and WACC) and backsolve for growth rate. This would be the implied growth rate. Say your implied growth rate is like 6%. This is quite unrealistic in the long run for a company's cash flows to grow at, so you'd probably revisit your exit multiples and scale them down.
Hope this helps
Thank you very much this helped a lot!
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