Thethreedifferentapproachestoadjustingdiscountratesare
similartotheapproachesusedtoestimateilliquiditydiscounts
onvalue.Theconstant liquiditypremium approachmirrors
the fixed liquidity discount, whereas the firm-specific
liquiditypremiumapproachesresembletheapproachesused
toadjusttheilliquiditydiscountforindividualfirms.Infact,
wecouldbuildregressionmodelsthatrelateexpectedreturns
onstockstomeasuresofilliquidityandusetheseregressions
to forecast discount rates for private firms.
Practitionershave triedto develop modelsthat incorporate
illiquidity.Onewidelypublicizedmodel,developedbyChris
Mercer, a principal at Mercer Capital, is called the
Quantitative Marketability Discount Model (QMDM).
74 TheQMDMallowsanalyststoadjustthediscountratefor
illiquidity factors,though theadjustmentis subjective,and
thenvaluesilliquidityasapercentoffirmvaluefordifferent
holdingperiods.Toillustratehowthemodelworks,consider
a firm with an expected cash flow next period of $1.00.
Assume that the appropriate discount rate, based on
fundamentalriskbutbeforeadjustingforliquidityrisk,is 9
percent and that theexpectedgrowth in thecash flowsin
perpetuity is 4 percent. This firmwould have an intrinsic
value of $20.
75 IntheQMDM,theanalystwouldadjustthediscountrate
for illiquidity (assume thathe would add 3 percent to the
discountrate to arrive ata required returnof 12 percent),
specifyaholdingperiod(sayfiveyears)andthepercentof
theavailablecashflowsthatwillbepaidout(say 60 percent).
The new firm value would then be computed as follows: