For the Entity and Equity Approaches, a Discount Rate is required in order to discount the future cash flows. The appropriate Discount Rate to use depends on the approach selected.
Valutico’s approach is based on the Capital Asset Pricing Model (“CAPM”) (see here for more information). The CAPM is based on observations from listed companies hence Valutico allows for the inclusion of an additional Cost of Equity premium (derived from the Qualitative Assessment, or directly entered by the user) to account for the difference in riskiness between the private company being valued and its peer group of larger, listed companies.
The detailed formulas for Cost of Equity, Cost of Debt and Weighted Average Cost of Capital are shown below.
Cost of Equity
CoE = Cost of Equity
Rf = Risk-Free Rate of Return
= Levered Beta
M = Market Rate of Return
Ep = Cost of Equity premium
Cost of Debt
CoD = Cost of Debt
Rf = Risk-Free Rate of Return
CS = Credit Spread
T = tax rate
Weighted Average Cost of Capital
WACC = Weighted Average Cost of Capital
E = Market Value of a firm’s Equity
D = Market Value of a firm’s Debt
V = Total Value of Capital (E + D)
CoE = Cost of Equity
CoD = Cost of Debt
T = Tax Rate
The Discount Rate tree on the Valuation screen provides an overview of how different inputs to Cost of Capital, that are used in the Income-Based Methodologies, are calculated.
Cost of Equity
Parameter | Input / Default | Can be overwritten directly? | Used in |
Unlevered Beta | Median of Peers from Peer Selection screen | Yes - Change Parameters menu on Valuation Creation |
CoE |
Tax rate | Based on Headquarters entered in Valuation Creation screen | Yes - Change Parameters menu on Valuation Creation |
CoE |
Target D/E ratio | Median of Peers from Peer Selection screen | Yes - Change Parameters menu on Valuation Creation |
CoE |
Market risk premium | Damodaran calculation: Country Credit Spread (based on credit rating) x Emerging Markets Volatility Adjustment + Mature Market Equity Market Risk Premium | Yes - Change Parameters menu on Valuation Creation |
CoE |
Levered Beta | = Unlevered Beta * [1 + (1 – Tax Rate) * (Debt / Equity)] | No, but Unlevered Beta can be set on Peers & Change Parameters menu on Valuation Screen |
CoE |
Company risk premium | Market risk premium x Levered Beta | No - Calculation | CoE |
Risk-free rate | Average yield of 10-year government bonds | Yes - Change Parameters menu on Valuation Creation |
CoE |
Cost of Equity Premium | Based on outcome of questionnaire on Qualitative Assessment screen | Yes - Change Parameters menu on Valuation Creation |
CoE |
Cost of Equity | Company risk premium + Risk-free rate + CoE premium | No - Calculation |
CoE |
Equity ratio | 1- D/C ratio | No - Calculation |
CoE
|
Cost of Debt
Parameter | Input / Default | Can be overwritten directly? | Used in |
Risk-free rate | Average yield of 10-year government bonds | Yes - Change Parameters menu on Valuation Creation |
CoD |
Spread over risk-free rate | Median of Peers from Peer Selection screen | Yes - Change Parameters menu on Valuation Creation |
CoD |
Cost of debt (pre-tax) | Risk-free rate + Spread over risk-free rate | No - Calculation | CoD |
Marginal tax rate | Based on Headquarters entered in Valuation Creation screen | Yes - Change Parameters menu on Valuation Creation |
CoD |
Cost of debt | Cost of debt (pre-tax) x (1 - Marginal tax rate) | No - Calculation | CoD |
Debt ratio | Median of Peers from Peer Selection screen | Yes - Change Parameters menu on Valuation Creation |
CoD |
WACC | Cost of Equity x Equity ratio + Cost of Debt x Debt ratio | No - Calculation |
CoD |