E.g. Telephone Division o Identify several other phone companies o If a typical phone company has a beta of 0.8, AA-rated debt, and a capital structure that is about 50% debt and 50% equity, we can use this information to develop a WACC as our discount rate. Subjective Approach Consider the project’s r isk relative to the firm overall o If the project has more risk than the firm, use a discount rate greater than the WACC o If the project has less risk than the firm, use a discount rate less than the WACC You may still accept projects that you shouldn’t and reject projects you should accept, but your error rate should be lower than not considering differential risk at all.
45 Example Risk Level Discount Rate Very Low Risk WACC – 8% Low Risk WACC – 3% Same Risk as Firm WACC High Risk WACC + 3% Very High Risk WACC + 8% Chapter 15: Raising Capital Early-Stage Financing and Venture Capital Venture Capital Private financing for relatively new businesses (Often high-risk ventures) in exchange for stock Usually entails some hands-on guidance The company should have an “exit” strategy o Sell the company – VC benefits from proceeds from sale o Take the company public – VC benefits from IPO Many VC firms are formed from a group of investors that pool capital and then have partners in the firm decide which companies will receive financing Some large corporations have a VC division Choosing a Venture Capitalist Financial Strength o The VCs need to have sufficient resources and finances for funding future stages. Style o Some VCs prefer to micro-manage while others only require occasional reporting. o Larger VC firms tend to be more rigid and bureaucratic than smaller “boutique” firms. References o Track record and past experiences of VC in dealing with difficult situations. Contacts o Extensive network of VC firm is important as they may help secure financing and resource connections. o Specialisation of VC firm may also be valuable. Exit Strategy o Since VCs are typically not long-term investors, it is important to evaluate their exit strategies and how they will cash out of the business.