Corporate Finance and Valuation
What the domain tests
Corporate finance and valuation tests capital budgeting, cost of capital, capital structure, and the two main valuation routes: discounted cash flow and market multiples.
Core rules
- WACC = (E/V) × Re + (D/V) × Rd × (1 − t). Use market values, not book values.
- Re via CAPM: Rf + β(Rm − Rf). Lever beta with Hamada when comparing firms with different capital structures.
- DCF: enterprise value = PV of FCFF discounted at WACC; equity value = EV − net debt.
- Terminal value: Gordon growth TV = FCFF_(n+1)/(WACC − g); g must be below WACC and usually below long-run GDP growth.
- Relative valuation: EV/EBITDA is capital-structure-neutral; P/E is an equity-earnings multiple.
Worked example
A firm has E = 600, D = 400, V = 1,000, Re = 12%, Rd = 6%, and tax = 25%. WACC = 0.6 × 12% + 0.4 × 6% × 0.75 = 7.2% + 1.8% = 9.0%. If FCFF next year is 90 and g = 3%, TV = 90/(0.09 − 0.03) = 1,500. If net debt is 200, equity value = 1,500 − 200 = 1,300, ignoring interim cash flows. The 9% discount rate applies to enterprise cash flows, not to equity cash flows.
Traps
Book weights; forgetting the tax shield on debt; using g ≥ WACC; discounting equity cash flows at WACC; confusing enterprise value with equity value; mixing levered and unlevered beta.