- When a company takes on more debt, its capitalisation rate (which can be applied to convert income to fair market value) increases.
TRUE FALSE
The computation of the capitalisation rate is not affected by the debt position of a business and as a result a change in an increase in debt, which invariably changes the financial leverage of the business will not have any impact on the capitalisation rate. Capitalisation rate is computed as:
Risk-free rate
+Equity risk premium (real)
+Specific industry risk premium
+Special entity premium
-Growth rate
= Capitalisation Rate
The answer is FALSE.
- When the discount cash flow method is applied in a business valuation, the method should be rejected if the terminal value makes up more than 50% of the estimated value.
TRUE FALSE
Valuation methods which relied on future earnings, such as the discounted cash flow method, draw value from two periods; the forecast period and the post-forecast period (from where the terminal value is estimated). There is no rule in business valuation regarding what the size of the terminal value should be. However, if the terminal value makes up a significant component of the estimated value (50% or more), it may be necessary for the valuator to review the analytical work because cash flows from the terminal periods cannot be accurately judged and totally relied on as the main source of value for a business. That said, the answer is still FALSE.
