You are considering an investment in an initial public offering by Marx Co., whi
ID: 2784789 • Letter: Y
Question
You are considering an investment in an initial public offering by Marx Co., which has performed very well recently, according to its financial statements. The firm will use some of the proceeds from selling stock to pay off some of its bank loans. How can you apply stock valuation models to estimate this firm’s value, when its stock is not yet publicly traded? Once you estimate the value of the firm, how can you use this information to determine whether to invest in it? What are some limitations involved in estimating the value of this firm?
Explanation / Answer
as per the financial statements of the company the same has performed very well. But the stock hasnt traded publicily. so to answer the first query.
1. How can you apply stock valuation models to estimate this firm’s value, when its stock is not yet publicly traded?
If it was publicliy traded the same has been answered by analysing the stock price but here we will analyse the sae by.
a. Comaparable company analysis - we will cehck the methods of the executiong workin similar industries or compan. We have a research menthod to anaylse the data by looking at the date of the similar company. This is the most simple and easy way to dig out the finding and work on them. Now the point s how we identify the samewe have to take care of certain things that are-
1 Size of the company
2 EBIT
3 Method of operating
4 A complete analytical detail list of the copanies with similar functioning.
along with it, the EBITDA , depreciation method, taxes should be the part of the criteria.
Value of target firm = Multiple (M) * EBITDA of target firm,
where the Multiple (M) is the average of Enterprise Value/EBITDA of comparable firms, and the EBITDA of the target firm is typically projected for the next twelve months.
2) Discounted cash flow method-
The Discounted Cash Flow (DCF) method ,we estimate the target’s discounted cash flow estimations, based on acquired financial information from its publicly-traded companies which are similar in nature.
Under the DCF method, we start by determining the applicable revenue growth rate for the target firm. This is achieved by calculating the average of growth rates of the comparable firms. We then make forecast of the firm’s revenue, operating expenses, taxes, etc., and free cash flows (FCF) of the target firm. The formula of free cash flow is given as:
Free cash flow =
EBIT (1-tax rate) + (depreciation) – (change in net working capital) – (capital expenditure)
We usually use the firm’s weighted average cost of capital (WACC) as the appropriate discount rate. To derive a firm’s WACC, we need to know its cost of equity, cost of debt, tax rate, and capital structure. Cost of equity is calculated using the Capital Asset Pricing Model (CAPM).
CAPM IS -
We estimate the firm’s beta by taking the industry average beta. Cost of debt is dependent on the target’s credit profile, which affects the interest rate at which it incurs debt.
3. he First Chicago Method is a combination of multiple-based valuation method and discounted cash flow method. The distinct feature of this method lies in its consideration of various scenarios of the target firm’s payoffs.We apply the same approach in the first two methods to project case-specific cash flows and growths rates for several years (typically a five-year forecast period). We also project the terminal value of the firm using the Gordon Growth Model.
The assumption of this method is -
Once you estimate the value of the firm, how can you use this information to determine whether to invest in it?
once the estimate is available then we can use it as
1. The estimated that derived are in positive values.
2. The assumptions made are shping the risk as downwards and the profits to the peaks.
3. The comparative analysis wuld help us to reac out to the deceiosn of investing in it
4. the Free cash flows are enough to absorb the investments.
What are some limitations involved in estimating the value of this firm?
As we can see, private company valuation is primarily constructed from assumptions and estimations.
1.While taking the industry average on multiples and growth rates provides a decent guess for the true value of the target firm,
2 We requireto adjust for a more reliable rate, excluding the effects of such rare events.
3, recent transactions in the industry such as acquisitions, mergers, or IPOs can provide us with financial information that gives a far more sophisticated estimate to the target firm’s worth.
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