Question

In the context of recent research on the Weighted Average Cost of Capital (WACC), the Adjusted Present Value (APV) and the Flow-to-Equity (FTE), which of these methods would you use for the following companies (explain your choice).

b) A start-up firm with no debt.

Answer 1

We use Flow-to-Equity (FTE) method to value a start-up firm with no debt.

WACC cannot be used as there is no debt and hence WACC reduces to cost of equity, which cannot be precited in cash of startup since neither the firm is expected to pay dividends nor the company would have substantial past returns data.

Adjsuted present value is the NPV of a firm if financed solely by equity + the present value of financing benefits. Here the financing benefits refers to the benefit that a firm get by raising debt due to the tax-shield from tax deductible interest payments.

FTE is the most appropriate method since, in an all equity startup firm, we need to estimate what cash-flows are generated for the equity raised.