Mergers & Inquisitions (M&I) 400 Practice Exam

Estimating the Weighted Average Cost of Capital (WACC) for a private company can be challenging due to the lack of readily available market data. The correct approach involves using the WACC of publicly traded companies that are comparable to the private company in question. This is effective because public companies have market-driven data that reflects the risk profiles, capital structures, and return expectations of similar firms within the same industry.

When estimating the WACC based on public company WACC, analysts typically adjust for differences in size, growth potential, and risk by using a comparable companies analysis. This method allows for a more informed approximation of what the private company’s WACC should be, taking into consideration the industry benchmarks and current market conditions.

In contrast, utilizing just market capitalization or solely focusing on the cost of debt may not provide a holistic view of the company’s capital costs. Historical data from the private company could also be misleading since it does not capture market dynamics and prices, which are crucial for understanding investor expectations and costs of capital in the current environment. Thus, obtaining a WACC estimate through a comparative analysis of public companies is the most reliable method for private firm valuation.