When valuing a private company using a DCF, how would you estimate the cost of equity if the company has no comparable public peers? The company is highly leveraged with a D/E ratio of 3.0.
An advanced Valuation question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
I would use the build-up method: start with the risk-free rate, add an equity risk premium (e.g., 5-6%), and then add size and industry risk premiums. To account for leverage, I would unlever the beta of a similar industry but adjust for the private company's higher leverage. Since no peers exist, I might use the Hamada equation with a bottom-up beta from industry averages, then relever at the target's D/E. Alternatively, I could use a modified CAPM with a subjective premium for the company's specific risk.
WHAT INTERVIEWERS LISTEN FOR
- ✓Build-up method or modified CAPM
- ✓Unlever and relever beta using Hamada
- ✓Include size and industry premiums
COMMON MISTAKES
- ✗Using CAPM without any beta estimate
- ✗Ignoring leverage effect on cost of equity
Reading isn't the same as answering under pressure.
Interviewers don't hand you the model answer — you deliver yours on a clock. Practice this and 1,000+ questions with AI feedback on every answer.
RELATED QUESTIONS
- What happens to the DCF value if you increase WACC by 1%?
- How do you calculate Beta for a private company?
- Should you use mid-year or year-end convention in a DCF?
- How do you handle negative cash flows in a DCF?
- What discount rate would you use for a highly leveraged company?
- A company has negative working capital because it collects cash from customers upfront but pays suppliers later. How does this affect your DCF valuation, and what trap must you avoid when projecting free cash flows?