rateforilliquidity,otherthantonotethatitcanbebackedout
of observed illiquidity discounts in restricted stock studies.
ILLUSTRATION 14.2: Estimating the Illiquidity Adjusted
Discount Rate for a Private Firm
Earlierin the chapter,we applied various estimatesof the
illiquiditydiscounttotheestimatedvalueof$1.796billionto
arriveatliquidity-adjustedvalues.Asanalternative,wecould
haveadjustedthediscountratethatweusedtovalueKristin
Kandy to reflect the illiquidity.
- Addinganilliquiditypremiumof4%(basedonthe
premium earned across all venture capital
investments) to the cost ofequity yieldsa cost of
equityof 20.26%and a costof capitalof 15.17%.
Usingthishighercostofcapitallowersthevalueof
equityin thefirmto $1.531million,about15.78%
lower than the original estimate.
78 - Allowing for the fact that Kristin Kandy is an
establishedbusinessthatisprofitablewouldallowus
tolowertheilliquiditypremiumto2%(basedonlate
stage venturecapital investments). This willlower
thecostofequityto18.26%,lowerthecostofcapital
to13.77%,andresultinavalueofequityof$1.658
million. The resulting illiquidity discount is 7.66%.
Twogeneralpointsshouldbemadeaboutadjustingdiscount
ratesforilliquidity.Thefirstisthatsmalladjustmentstothe
discountratewilltranslateintolargeilliquiditydiscounts.The
second is that the length of the periodthat we make the
illiquidity adjustmentfor willaffect the magnitude of the