- 18 -
value using the discount rate. Under the DCF method, the present
value of the cash-flow projections and the terminal value are
ascertained using the appropriate discount rate, and the sum of
those amounts is the fair market value of the company.
The discount rate is calculated using the weighted average
cost of capital (WACC) formula, which combines the after-tax
costs of debt and equity into a weighted average overall cost of
capital. The cost-of-equity capital is equivalent to the long-
term expected annual rate of return an investor seeks on an
investment in stock. It is calculated using the capital asset
pricing model (CAPM).
One of the variables in the CAPM formula is beta, which
measures the volatility in financial returns of a target firm.
Beta is calculated by comparing the movement in the returns of a
stock against the movement in the returns of the stock market as
a whole, which has a beta of 1. For example, if a stock
generally increases 2 percent in price when the market increases
by 1 percent, the stock would have a beta of 2 (2 divided by 1).
Shapiro calculated beta for Schlegel UK using the average
beta from nine companies that he determined to be in a similar
business as Schlegel UK. The average beta for the nine companies
was .87 with a range from .56 to 1.11. Because Schlegel UK
maintains relatively little debt in its capital structure,
Shapiro then adjusted for the different degrees of debt leverage
Page: Previous 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 NextLast modified: May 25, 2011