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Privately Held Company Valuation and Cost of Capital

  • Alfonso A. Rojo-Ramírez EMAIL logo
Veröffentlicht/Copyright: 15. März 2014
Journal of Business Valuation and Economic Loss Analysis
Aus der Zeitschrift Journal of Business Valuation and Economic Loss Analysis Band 9 Heft 1

Abstract

The aim of this paper is to contribute to a deeper knowledge of the discount rate in the framework of privately held company (PHC) valuation. Their main purpose is to test if the expected rate of return on equity differs between PHCs and quoted companies and if their accounting rate of return is greater than the cost of equity capital. This paper contributes in two different ways: first, distinguishing between the so-called purely financial investor and the economic risk investor to construct a model that permits to calculate the PHC’s cost of equity capital; second, assuming rational economic behavior. It is argued that in the valuation of non-quoted companies, investors need to be able to choose a model that goes beyond the beta of the capital asset pricing model (CAPM), proposing the three-component model based on Rojo-Ramírez, Cruz-Rambaud and Alonso Cañadas (2011). The empirical analysis leads us to conclude that the use of this model improves the overestimated value of a company by applying the discount rate of the CAPM (between 28% and 49%), which is consistent with professional practice.

Keywords: firm valuation; discount rate; equity premium; privately held companies; economic risk investor

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  1. 1

    For example, in the EU, more than 99.5% of businesses are MSME. Without medium-sized enterprises, this figure reaches 98.7%. (http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Small_and_medium-sized_enterprises). Data are from 2009.

  2. 2

    This notation is used in a similar way to Artemenkov, Mikerin, and Artemenkov (2008) who, for valuation effects, differentiate between valuations based on portfolio theory (Investment-Financial Valuation) and professional valuation. Kerins, Smith, and Smith (2002) use the terms “well-diversified investor” vs “venture capitalist.”

  3. 3

    Note that an efficient market is in the long run, as Malkiel (2003) suggests.

  4. 4

    “Venturer” is used here as defined by Garvey (2001).

  5. 5

    It has been assumed that ERI is risk-seeking. After the Bowman (1980) paradox, we know that an investor can be risk-seeking or risk-averse according to the industry average (Fiegenbaum and Thomas 1988).

  6. 6

    For example, Gil and Ruiz-Martínez (2004) consider a company to be a portfolio of assets with systematic risk represented by beta.

  7. 7

    An economic portfolio is equivalent to investing all of one’s resources in a financial asset replicating a benchmark market index whose profitability is RM and whose standard deviation is σM and simultaneously borrowing at the risk-free interest rate (Rf) and investing the obtained amount in an economic activity whose profitability is Re and whose standard deviation is σe. The mathematical proof of this result can be seen in the study by Rojo-Ramírez, Cruz-Rambaud, and Alonso-Cañadas (2012).

  8. 8

    Because some companies have controlling participations, we also calculated profitability by adding financial income (FInc):

    RFdIT=EBITDA+IFin−FEx-TAXEm

    Both profitabilities, although accounting return ignores depreciation and amortization, are quite close to economic profitability.

  9. 9

    Note that the SABI database does not show beta for all years. We have therefore used the beta existing in December of the last year.

  10. 10

    It should be kept in mind that RFdIT is greater than ROEaT.

  11. 11

    Índice General de la Bolsa de Madrid (Madrid Stock Exchange General Index).

  12. 12

    For the Spanish market, see Garrido and García (2010).

Published Online: 2014-3-15
Published in Print: 2014-1-1

©2014 by De Gruyter

Artikel in diesem Heft

  1. Frontmatter
  2. Research Articles
  3. Privately Held Company Valuation and Cost of Capital
  4. Negative Value Indicators in Relative Valuation – An Empirical Perspective
  5. Effect of Liquidity on Size Premium and its Implications for Financial Valuations
  6. Private Placement Real Estate Valuation
  7. The Specific Value of Junior Mining Companies: Are Common Valuation Methods Appropriate?
  8. DCF-Valuations of Companies in Crisis: Distress-Related Leverage, Identification of Risk Positions, Discounting Techniques, and “Beta Flips”
https://doi.org/10.1515/jbvela-2013-0017
Schlagwörter für diesen Artikel
firm valuation; discount rate; equity premium; privately held companies; economic risk investor

Artikel in diesem Heft

  1. Frontmatter
  2. Research Articles
  3. Privately Held Company Valuation and Cost of Capital
  4. Negative Value Indicators in Relative Valuation – An Empirical Perspective
  5. Effect of Liquidity on Size Premium and its Implications for Financial Valuations
  6. Private Placement Real Estate Valuation
  7. The Specific Value of Junior Mining Companies: Are Common Valuation Methods Appropriate?
  8. DCF-Valuations of Companies in Crisis: Distress-Related Leverage, Identification of Risk Positions, Discounting Techniques, and “Beta Flips”
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