In the first two videos, we are shown how we can calculate WACC, the weighted average cost of capital, using the formula described in the first question below. In the first video, it is shown how to calculate WACC for a real firm, in that case Gap Inc. In the last video, it is explained to us how to value a private company. Also, in this video, the three main categories of private companies are explained to us. These are: Money Business (small family-owned business), Meth Business (Venture-backed startups), and Empire Business (large private companies). Additionally, in the last video, the author explains the main differences of these three categories. The difference of these lies mainly with accounting with the three financial statements, valuation, and the DCF analysis. One of the most interesting pieces of information that the author mentioned, when he explained the differences, was when he talked about the discount rate. The author stated that the discount rate must be higher for private companies. Besides, he mentioned that one cannot calculate the discount rate in the traditional way because private companies do not have betas or market caps.

1. How is the WACC calculated?

WACC, the weighted average cost of capital, is a financial metric used to measure the cost of capital to a firm. The two main sources a company has to raise money are equity and debt. WACC is the average of the costs of these two sources of finance and it gives each one the appropriate weighting. The formula is:

WACC = w_dr_d(1 – T) + w_pr_p + w_cr_s 

Wd is the target proportions of debt

Wp is preferred stock

Wc stands for common equity.

(1-T) is after tax cost of debt

rp is cost of common stock

rs cost of common equity

1. What is the economic meaning of WACC calculation inputs, particularly those derived from the market?

The weighted average cost of capital (WACC) is a calculation that allows firms to understand the overall costs of acquiring financing. Capital inputs generally come in the form of debt and equity. The cost of capital is the expected return to equity owners or shareholders and to debtholders. WACC tells us the return that both stakeholders can expect. WACC represents the investor's opportunity cost of taking on the risk of putting money into a company.

1. How can one consider the use of comparable company WACC calculations in determining a company's chosen discount rate?

When doing a Comparable Company Analysis, it is very important to do it in the same way. That is, we have to screen it by industry and size, as expressed by the author in the third video on private company valuation. For example, the author explains that a small business with under $10 million in revenue cannot be compared to a $400 million revenue company with physical campuses and hundreds of employees. For instance, if the company we are valuing is greater than an Empire Business, we might apply something small, like a 3-5% discount, to account for its lack of liquidity. On the other hand, if the company is a 2 people consulting firm, we could apply a 25%, 30%, or even a 50% discount to account for the lack of liquidity and completely different scale. Furthermore, for Meth Businesses (startups), the author explains that we might not apply a discount at all because it is about to be public.

1. How do changes in markets impact discount rates?  What are the implications of that on the WACC?

The discount rate represents the required rate of return for an investor to invest in a business. The discount rate is the interest rate used to determine the present value of future cash flows in a discounted cash flow (DCF) analysis. This helps determine if the future cash flows from a project or investment will be worth more than the capital outlay needed to fund the project or investment in the present. In discounted cash flow analysis, WACC is used as the discount rate applied to future cash flows for deriving a business's net present value. In the third video, an important fact mentioned is that the discount rate should be higher for a private company. In addition, the discount rate also depends on the potential buyer or investors. To be more specific, if the buyer is a big public company with diverse shareholders and the company is about to go public, the discount rate will be lower because there is more diversification and therefore less risk. But if the buyer is a single, non-diversified private conglomerate or an individual, the discount rate will be higher.