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Pregunta # 2

1. Determine the optimal WACC and discuss the use of multiple valuation techniques in reducing risks.

Answer:

As we know that, the weighted average cost of capital is:

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Here,

Kd=Cost of debt before tax=7.5%

T=Tax rate=42%

Wd=Weight of debt in the capital structure

Ke=Cost of Equity

We=Weight of equity in the capital structure

Now,

Weight of Debt:

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Cost of equity:

We have,

Risk free rate=4.36%

Market rate of return (S&P)=13.08% (source: standardandpoors.com)

Let,

Beta of the company=0.8

Hence,

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Weight of Equity:

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Hence,

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Valuation Techniques:

There are three type of important valuation techniques, discounted cash flow valuation (DCF), relative valuation, and contingent valuation.

i) Discounted cash flow valuation:

Discounted cash flow valuation is the foundation on which all other valuation techniques are built. It uses the present value rule where asset present value is calculated by discounting it by the cost of capital used in purchasing the asset. So,

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Here,

N= life of the asset

CFt= Cash flow in the period t

K=Discount rate or the cost of capital employed in the asset.

The discounted cash flow valuation technique is an important and easy technique to value an asset but it has certain disadvantages. Its not possible to find out the precise value of cash flow in the future and also to find out the correct discount rate. So the price may deviate from the intrinsic value due to market conditions in the future.

ii) Relative Valuation:

It is based on the fact that the value of the asset will be equal to the similar asset available in the market. So in relative valuation, the value of the asset is derived from the pricing of comparable asset. This is the most used valuation technique....