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Corporate Finance, 5th Edition
book

Corporate Finance, 5th Edition

by Pierre Vernimmen, Pascal Quiry, Maurizio Dallocchio, Yann Le Fur, Antonio Salvi
December 2017
Intermediate to advanced content levelIntermediate to advanced
1024 pages
32h 22m
English
Wiley
Content preview from Corporate Finance, 5th Edition

Chapter 29 The cost of capital

Mirror, mirror on the wall . . .

Determining the cost of capital, or weighted average cost of capital (WACC), is not a simple task, but it is one of the fundamentals of finance. The cost of capital has to be factored into investment decisions because it is the rate that is used for discounting cash flows for NPV or comparing with the IRR. Cost of capital is also used to determine enterprise value (see Chapter 31). Truly, its importance can hardly be understated.

But before reading on, it is imperative to understand the distinction between cost of capital, which is the weighted average cost of the capital contributed to the firm, and cost of equity, which is just one component of the weighted average of the cost of capital. The reader should also take care not to rely excessively on spreadsheets without any prior reflection.

Section 29.1 The cost of capital and the risk of assets

When markets are in equilibrium, any investor with a perfectly diversified portfolio holds a fraction of both the company’s equity and its debt. This is known as the CAPM, as was discussed in Chapter 19. In other words, each investor holds a share of the company’s operating assets, since this is equal to the sum of equity and ...

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Publisher Resources

ISBN: 9781119424482Purchase book