Key Rule 5

Question 1

Key rule 5

Answer 1

Factors which impact a DCF and WACC

Question 2

Overall Impact

Answer 2

Discount Rate and Terminal Value tend to have the biggest impact here, if a company’s revenue growth rate or margins change dramatically, those could change DCF significantly as well

Question 3

even a 1% increase or decrease in the Discount Rate makes

Answer 3

far more of an impact than a 1% increase or decrease in revenue or revenue growth or EBIT margins because that Discount Rate affects everything in the analysis

Question 4

Rules of thumb for cost of equity:

Answer 4

• smaller companies generally have higher cost of equity as expected returns are higher
• companies in emerging and fast-growing geographies and markets also tend to have higher CoE for same reason
• additional debt raises CoE
• additional equity lowers the CoE, as % of debt in a company’s capital structure decreases
• using historical vs calculated Beta doesn’t have a predictable impact - could go either way depending on set of comps.

Question 5

Rules of thumb for WACC:

Answer 5

• assuming that the companies all have identical capital structures, higher WACC for smaller companies + emerging markets as investors demand higher return for taking this risk
• additional debt reduces WACC because debt is less expensive than equity, due to interest payments being tax deductible. Levered beta will rise, but additional debt in WACC formula more than makes up for increase
• additional preferred stock also generally reduces WACC because preferred stock tends to be less expensive than Equity
• higher debt interest rates increases WACC as it increases cost of debt.