Business valuation USING WACC BY Modigliani & Miller (M&M) Formula

Income of R50 000 in years times

Required:
Calculate PV assuming that the interest rate is 10% pa.
Answer:
1/1.1 x 50 000

WACC
Cost of capital

Debt Equity
Interest Dividends = Cost of capital

1 2 3
MARKST 65 60 50

Mean/Av pass mark = 65+60+50/3 =

Unlisted Co Listed Co
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How to value an unlisted Company?
Use a proxy company
Must be a listed company
Similar to the unlisted company that is in question
WACC
Ke = D/Po
Does not consider risk factor into it
ANY INVESTMENT HAS A RISK ATTACHED TO IT
The higher the risk, the greater the return

Capital Asset Pricing Model (CAPM) = Risk

Div growth Model = Risk

M&M
Ke = Rf + (Rm – Rf) Beta
Ke = required return from individual security
Beta = Beta factor of individual security
Rf = risk free rate of interst
Rm = return on market portfolio

Example 1
ABC Co has a gearing ratio (D : E) of 1 : 2; the shares have a beta value of 1.45 (the
equity beta); and the company rate is 30% pa.
Required:
Calculate ungeared beta factor

Beta u = Beta g x 2
2 + 1 x (1 – 0.3)
= 1.45 x 2
2 + 1 x (1 – 0.3)
= 1.074
Debt after tax

Time value of money

Currently, Equity RE is 12% and Debt is 7%. Equity value is R50 000 and Debt is
R100 000 payable over 3 year. Debt was acquired at 5% pa.
Required
Calculate PV of a Debt

Principal Interest
Value R100 000 5 000 (100 000 x 5%)
PVIF (rate) 4.9% 4.9%
Single (one off)
PV 1/1.049

PV 1/(1.049)3
1/1.049 = 0.
= 0.
= 0.
=
Interst rate x (1 – t)
7% x 0.7
4.9%
Example 1

We are trying to value the Aldo Co, an unlisted company with an estimated
debt:equity ration of 1:2. Post-tax flows before financing charges have been
forecasted, so a suitable WACC is now needed for discounting.
Information for Nzuza Co. a listed company in the same business sector as Aldo Co
is as follows:
Nzuza Co
Current geared (equity) beta 1.70
Current capital structure ratio (D:E by market value) 1:1

The tax rate is 30% and the return on the stock market has been 12% per annum in
recent years. Debt is assumed to be risk free and has a pre-tax cost of 5% per
annum.
Required
Calculate a suitable WACC for Aldo Co using M & M Formula.

1st step
Calculate ungeared (Nzuza Co)/ Asset beta

Beta ungeared = Beta geared x VE

VE + VD (1 – t)
= 1.7 X 1
1 + 1 (1 – 0.3)
= 0.09
BODMAS
1 + 1 x 0.7
1 + 0.7
1.07
1/1.07
0.94
Step 2
Apply ungeared beta into CAPM formula to give an ungreared cost of equity.

Ke = Rf + (Rm – Rf) Beta

Ke = 5% + (12% - 5%) x 0.94
Ke = 5% + 7% x 0.94
Ke = 5% + 6.58%
Ke = 11.58%

Step 3
WACC use the M&M Formula
WACC = Keu x (1 – tL)
WACC = 11.58% x (1 – 30% x (1/3))
WACC = 11.58% x (1 – 30 x 0.3333)
= 10.42%

Apply BODMAS

Equity 70 000 0.7

Debt 30 000 0.3
Total 100 000 1.00

70 000 30 000
7 : 3 10