A controlling interest can change the capital structure. When valuing a controlling interest, the valuator will generally (subject to the valuator’s purpose and standard of value) base the weighted average cost of capital (WACC) on the optimum capital structure or the average industry capital structure. In most cases, the optimum capital structure and the average industry capital structure is the same. If a difference did exist between the optimum capital structure and the average industry capital structure, the valuator will generally utilize the optimum capital structure for the subject interest. The cost of capital will generally be based on the following:
Debt Capital Controlling Non-Controlling Interest
The cost of debt capital can generally be determined based on the current borrowing rate (credit risk) of the subject company/business. However, in cases where the subject company/business does not have debt capital, the valuator can determine the cost of debt capital from various sources that monitor the cost of debt capital (market data).
Equity Capital Controlling Non-Controlling Interest
The cost of equity capital can generally be determined based on a build-up approach, CAPM, or published sources of cost of equity capital (market data).
Non-Controlling Interest Controlling Non-Controlling Interest
A non-controlling interest cannot change the capital structure of the Company. If the valuator uses Net Cash Flow to Invested Capital as a benefit stream in a DCF model with a constant WACC where the capital structure is changing over the forecast period, the net present value of the future cash flows will be distorted by utilizing an inappropriate application of a constant WACC (when the cost of capital is constantly changing) as a discount rate applied to the net cash flows to invested capital representative of a constantly changing capital structure. The valuator should avoid using Net Cash Flow to Invested Capital as a benefit stream in a DCF model when the capital structure is constantly changing during the forecast period. Controlling Non-Controlling Interest