BUILD$-$UP METHOD SIMULATION

Assignment: Prepare a capitalization rate and company specific risk using the

buildup method based on the information below. Please justify any judgments

with facts and evidence.

Risk Free Rate $\_\_\_\_\_\_\_\_\_\_\_\_$

Equity Risk Premium $\_\_\_\_\_\_\_\_\_\_\_\_$

Size Premium $\_\_\_\_\_\_\_\_\_\_\_$

Specific Company Risk $\_\_\_\_\_\_\_\_\_\_\_\_$

After$-$Tax Discount Rate $\_\_\_\_\_\_\_\_\_\_\_\_$

Growth Rate $\_\_\_\_\_\_\_\_\_\_\_\_$

After$-$Tax Capitalization Rate $\_\_\_\_\_\_\_\_\_\_\_\_\_$

Simulation Facts:

Risk$-$Free Rate A $$safe$$ rate or the amount that any investor would receive for a

$$risk$-$free$$ investment. A U$.$S$.$ Treasury bond with approximately $20$ years

remaining to maturity is the typical benchmark. The rate of return for these types

of bonds on or around December $31,20$XX $(2\mathrm{.}47\%).$

An equity risk premium that represents the additional premium an investor is

receiving for the risk of investing in corporate equities over risk$-$free investments

located in the Duff & Phelps, $20$XX Valuation Handbook $(7\mathrm{.}00\%).$

A small company risk premium that represents the beta$-$adjusted size premium as

illustrated in the $10$th deciles of Duff & Phelps Key Variables in Estimating the

Cost of Capital located in Duff & Phelps, $20$XX Valuation Handbook $(11\mathrm{.}98\%)$

A Company$-$specific risk premium is added to the discount rate. The premium is

comprised of various factors such as company performance, management, future expectations and, the size of the company. In this valuation analyst$$s judgment, an

additional $\_\_\_\_$ premium should be added to the discount rate.

Use the following subject company characteristics in your determination of

Company$-$Specific Risk range $1\%-10\%$

$1.$ Business revenue growth company management has outperformed inflation.

$2.$ Company$$s financial risk. Debt$-$free firms have a much lower risk of financial failure than

heavily leveraged businesses. The subject company has moderate debt levels.

$3.$ Operational risks. Consider the difficulty and costs associated with growing your business.

Subject company is need of technology upgrades and retraining staff.

$4.$ Business profitability Is in line with industry peers.

$5.$ Customer concentration. The subject company relies on a few large customers for most of

its income.

$6.$ Product concentration. The subject company has a diverse product mix

$7.$ Market concentration. The subject company sells into a market that is limited$.$

$8.$ Competitive position. A company has a well$-$protected market niche but is exposed to large,

well$-$funded competitors.

$9.$ Quality of management team. The subject company has experienced business managers

$10.$ Quality of staff. Staff is made of long$-$term employees.

Growth rate considerations select a$,$ b$,$ or c$.$ Justify your decision:

a: The $5-$year average rate of inflation in the United States $(1\mathrm{.}31\%).$

Year Revenue

$1$ $$9,378,517$

$2$ $$9,821,595$

$3$ $$10,229,991$

$4$ $$10,495,261$

$5$ $$11,088,018$

b: Average Annual Growth Rate

c: Compound Growth

d: The discounted cash flow method is directly related to capitalization of cash

flow$/$earnings method

Prepare$$of$$Discounted$$Cash$$Flow$$Valuation$$based$$on$$the$$following$$assumptions:

Discount$$Rate$($After$$Tax$)22\mathrm{.}42\%$

Growth$$Rate $16\mathrm{.}55\%$

Cash$$Flow$$Year$1(20$X$5)4,094,256$ $$$

Discounted$$Earnings$/$Cash$$Flow

$20$X$520$X$620$X$720$X$820$X$920$X$10$ Terminal$$Year$20$X$11$

Growth $4,094,256$ $$$

Present$$Value$$Factor $$

Present$$Value $$

Valuation Method Indicated Value

Discounted Earnings$/$Cash Flow Method