Final answer:
To value equity using CFTE, forecast future cash flows, discount to present value at cost of equity, and add the market value of debt to find total firm value. Small firms raise funds from private investors due to costs and regulations, prefer IPOs for more capital, and venture capitalists have better information than bondholders. Bonds and loans both provide debt financing with obligations but differ in repayment flexibility and lender involvement.
Step-by-step explanation:
To value the equity of a dividend-paying levered firm using the Cash Flow to Equity (CFTE) approach, you need to forecast the firm's levered free cash flows to equity holders. Levered free cash flow is the amount of cash a firm generates after meeting all its financial obligations, including payments on debt. The procedure involves projecting the company's future cash flows and then discounting them back to their present value at the cost of equity. This is done because the value of money decreases over time due to inflation and opportunity costs of capital.
The total value of the firm is known as the enterprise value and includes not only equity but also the debt and other liabilities. To obtain this, one might start by valuing the equity as detailed above and then add the market value of the debt and subtract any non-operating assets like excess cash on the balance sheet.
For early-stage corporate finance questions, very small companies tend to raise money from private investors because an IPO is costly and requires complying with extensive regulatory requirements, which a very small company may not be able to afford or justify given its small scale. Small, young companies might prefer an IPO to have access to more capital and improve public awareness, while avoiding the high interest costs associated with loans when their cash flows are uncertain. Venture capitalists often have better information about a small firm's potential because they actively engage in due diligence, unlike bondholders who have to rely on publicly available information.
A bond and a bank loan are similar from the firm's perspective in that both are ways of raising capital through debt financing, and the firm has an obligation to make periodic interest payments and return the principal amount at maturity. However, they differ in terms of the flexibility in repayment terms, the involvement of the lender in company affairs, and the ease of transferability to other parties.
In the case of equity calculations for a home, if someone like Eva or Fred bought a house for $200,000 and put 10% down, they would initially have $20,000 in equity since 10% of $200,000 is $20,000. This figure does not account for changes in property value or principal repayments over time.