There is a privately held company X Pvt. Ltd that is operating into the retail space, and is now scouting for angel investors. The unleveraged beta…

CA Final · Advanced Financial Management · MTP · November 2024
There is a privately held company X Pvt. Ltd that is operating into the retail space, and is now scouting for angel investors. The unleveraged beta based on the industry in which it operates is 1.8, and the average debt to equity ratio of X Pvt. Ltd. is hovering at 40:60. The rate of return provided by risk free GOI Bonds is 5%. The rate of market return for the industry is 11%. The FCFs for the next 3 years are as follows: Year 1 Year 2 Year 3 Free Cash Flows (₹ Crore) 10 12 15 The pre-tax cost of debt is 12%. Assume a tax regime of 30%. Determine the potential value to be placed for X Pvt. Ltd, based on above-mentioned FCFs. Note: Use PVF and round off calculations upto 3 decimal points.

Suggested Answer and Working Notes:

To compute the value of A Ltd. first, we shall calculate WACC of the company. Since its share is not trading in the market, we shall use proxy beta to calculate the cost of equity. Since the unlevered beta of the industry is 1.8 the levered beta of the company will be: 1.8[1+(1-0.3)*40/60)] = 2.64 The Cost of equity in accordance with CAPM = r (f) + β (Rm – Rf) = 5% + 2.64 (11% - 5%) = 20.84% The WACC = Cost of Equity + Cost of Debt = 20.84 (60/100) + 12.0 (1-0.3) (40/100) = 15.864 Finally, the free cash flows can be discounted at the WACC obtained above as under – Year 1 Year 2 Year 3 Free Cash Flows 10 12 15 Discount factor 0.863 0.745 0.643 PVs of cash flows 8.63 8.94 9.645 Value of X Pvt. Ltd. (₹ Crore) 27.215

Topics: Business Valuation

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