“The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset.” – Warren Buffett
On Monday Berkshire Hathaway announced it’s purchasing Precision Castparts for $37 billion (here is our analysis of Precision Castparts from earlier in the week). One of the fascinating aspects of this transaction is that it provides us a front row seat into how Mr. Buffett runs his own discounted cash flow model and the discount rate he’s using to value companies.
We’ve run our own discounted cash flow (DCF) model on Precision Castparts and backed into the cost of equity where both the model’s value and transaction value equal $37 billion. This analysis reveals that Warren Buffett likely used a cost of equity between 7.4% and 7.9% in his own DCF model.
Deriving Warren Buffett’s Cost of Equity
We’ve run three scenarios to derive the cost of equity Warren Buffett used to value Precision Castparts. Here is a summary of the different factors we evaluated to arrive at the implied cost of equity:
|High Growth Scenario||Moderate Growth Scenario||Low Growth Scenario|
|Net Capital Investment||23.0%||12.5%||3.2%*|
|Implied Cost of Equity||7.9%||7.7%||7.4%|
* Note: This equals the company’s depreciation and amortization expense.
To download a copy of the Excel model with the High Growth Scenario, click here. To run the other scenarios simply enter the above assumptions into the model.