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Cost of Capital: Applications and Examples, + Website, 5th Edition

Name: Cost of Capital: Applications and Examples, + Website, 5th Edition
ISBN: 9781118555804

by Shannon P. Pratt, Roger J. Grabowski, Richard Brealey

April 2014

Intermediate to advanced

1344 pages

44h 24m

English

Wiley

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Cover Page
Title Page
Copyright
Dedication
Contents
About the Author
Foreword
Preface
EFFECT OF FEDERAL RESERVE ACTIONS ON LONG-TERM INTEREST RATESWHY DID WE UNDERTAKE UPDATING THE BOOK?WHAT'S NEW IN THIS EDITIONABOUT THE WEBSITEAUDIENCES FOR THE BOOKFINAL THOUGHTS
Acknowledgments
PART One: Cost of Capital Basics

CHAPTER 1: Defining Cost of Capital
INTRODUCTIONCOMPONENTS OF A CAPITAL STRUCTURECOST OF CAPITAL IS A FUNCTION OF THE INVESTMENTCOST OF CAPITAL IS FORWARD-LOOKINGCOST OF CAPITAL IS BASED ON MARKET VALUECOST OF CAPITAL IS USUALLY STATED IN NOMINAL TERMSCOST OF CAPITAL EQUALS THE DISCOUNT RATEDISCOUNT RATE IS NOT THE SAME AS CAPITALIZATION RATESTANDARD (BASIS) OF VALUESUMMARY
CHAPTER 2: Introduction to Cost of Capital Applications: Valuation, Project Selection, and Ratemaking
INTRODUCTIONNET CASH FLOW IS THE PREFERRED ECONOMIC INCOME MEASURECOST OF CAPITAL IS THE PROPER DISCOUNT RATEPRESENT VALUE FORMULAEXAMPLE: VALUING A BONDAPPLICATIONS TO BUSINESSES, BUSINESS INTERESTS, AND CAPITAL BUDGETING PROJECTSAPPLICATIONS IN RATEMAKINGSUMMARY
CHAPTER 3: Net Cash Flow: The Preferred Measure of Economic Income
INTRODUCTIONDEFINING NET CASH FLOWNET CASH FLOWS SHOULD BE PROBABILITY-WEIGHTED EXPECTED VALUESWHY NET CASH FLOW IS THE PREFERRED MEASURE OF ECONOMIC INCOMESUMMARYADDITIONAL READING
APPENDIX 3A: Alternative Measures of Economic Income
INTRODUCTIONCAPITAL CASH FLOWADJUSTED PRESENT VALUERESIDUAL INCOME
CHAPTER 4: Discounting versus Capitalizing
INTRODUCTIONCAPITALIZATION FORMULAFUNCTIONAL RELATIONSHIP BETWEEN DISCOUNT RATE AND CAPITALIZATION RATEMAJOR DIFFERENCE BETWEEN DISCOUNTING AND CAPITALIZINGCONSTANT GROWTH OR GORDON GROWTH MODELCRITICISMS OF THE GORDON GROWTH MODELCOMBINING DISCOUNTING AND CAPITALIZINGEQUIVALENCY OF DISCOUNTING AND CAPITALIZING MODELSSUMMARY
APPENDIX 4A: Equivalency of Capitalizing Residual Income
CHAPTER 5: Discounting—Beyond the Basics
INTRODUCTIONMIDYEAR CONVENTIONMATCHING PROJECTION PERIODS TO FINANCIAL STATEMENT DATES: PARTIAL FIRST YEARCHANGING RISK OVER TIMEDURATION OF AN INVESTMENTSUMMARY
CHAPTER 6: Relationship between Risk and the Cost of Capital
INTRODUCTIONDEFINING RISKHOW RISK AFFECTS THE COST OF CAPITALTYPES OF RISKMEASURING RISKINESS OF NET CASH FLOWSASC 820 FAIR VALUE MEASUREMENT: CASH FLOWS AND PRESENT VALUE DISCOUNT RATESSUMMARY
PART TWO: Estimating the Cost of Equity Capital
INTRODUCTION
CHAPTER 7: Risk-free Rate 1
INTRODUCTIONRISK-FREE RATE REPRESENTED BY U.S. GOVERNMENT SECURITIESWHY CONSIDER MULTIPLE MATURITIES?SELECTING THE BEST RISK-FREE MATURITYCOMPONENTS OF THE RISK-FREE RATESELECTING THE BEST RISK-FREE YIELDSUMMARY
CHAPTER 8: Equity Risk Premium 1
INTRODUCTIONDEFINING THE EQUITY RISK PREMIUMUNCONDITIONAL ERPCONDITIONAL ERPCONCLUDING ON AN ERPSUMMARYADDITIONAL READING
APPENDIX 8A: Deriving ERP Estimates 1
REALIZED RISK PREMIUM ( EX POST ) APPROACHCOMPARING INVESTOR EXPECTATIONS TO REALIZED RISK PREMIUMSUSING THE GEOMETRIC AVERAGE FOR COMPOUNDING AND THE ARITHMETIC AVERAGE FOR DISCOUNTINGIMPLIED EX ANTE ERP ESTIMATES
APPENDIX 8B: Other Sources of ERP Estimates
CHAPTER 9: Build-up Method
INTRODUCTIONFORMULA FOR ESTIMATING THE COST OF EQUITY CAPITAL BY THE BUILD-UP METHODRISK-FREE RATEEQUITY RISK PREMIUMSIZE PREMIUMCOMPANY-SPECIFIC RISK PREMIUMEXAMPLE OF THE BUILD-UP METHOD USING MORNINGSTAR DATAEXAMPLE OF THE BUILD-UP METHOD USING DUFF & PHELPS SIZE STUDY DATASUMMARY
CHAPTER 10: Capital Asset Pricing Model
INTRODUCTIONCONCEPT OF MARKET OR SYSTEMATIC RISKBACKGROUND OF THE CAPITAL ASSET PRICING MODELMARKET (OR SYSTEMATIC) AND UNIQUE (OR UNSYSTEMATIC) RISKSUSING BETA TO ESTIMATE EXPECTED RATE OF RETURNMODIFYING CAPMMODIFIED CAPM COST OF CAPITAL FORMULAEXAMPLES OF A CAPM MODELASSUMPTIONS UNDERLYING THE CAPITAL ASSET PRICING MODELSUMMARY
CHAPTER 11: Beta: Differing Definitions and Estimates 1
INTRODUCTIONESTIMATION OF EQUITY BETADIFFERENCES IN ESTIMATION OF EQUITY BETASMODIFIED BETAS: ADJUSTED, SMOOTHED, AND LAGGED“FULL-INFORMATION” EQUITY BETAPEER GROUP EQUITY BETAFUNDAMENTAL EQUITY BETAEQUITY BETA ESTIMATION RESEARCHESTIMATION OF DEBT BETASOTHER BETA CONSIDERATIONSSUMMARY
APPENDIX 11A: Examples of Computing OLS Beta, Sum Beta, and Full-information Beta Estimates
INTRODUCTIONCOMPUTING OLS AND SUM BETA ESTIMATES EXAMPLECOMPUTING FULL-INFORMATION BETA ESTIMATE EXAMPLE
APPENDIX 11B: Estimating Beta: Interpreting Regression Statistics
INTRODUCTIONEVALUATING BETA ESTIMATION OUTPUTEVALUATING REGRESSION OUTPUTANOVA Table
CHAPTER 12: Unlevering and Levering Equity Betas 1
INTRODUCTIONFORMULAS FOR UNLEVERING AND LEVERING EQUITY BETASCHOOSING AMONG UNLEVERING AND LEVERING FORMULASADJUSTING ASSET BETA ESTIMATES FOR DIFFERENCES IN OPERATING LEVERAGEADJUSTING ASSET BETA ESTIMATES FOR EXCESS CASH AND INVESTMENTSUNLEVERING EQUITY VOLATILITYSUMMARY
CHAPTER 13: Criticism of CAPM and Beta versus Other Risk Measures 1
INTRODUCTIONCAPM ASSUMPTIONS AND BETA AS A RISK MEASUREPROBLEMS WITH CAPM ASSUMPTIONSTESTING ASSET PRICING MODELSRISK MEASURES BEYOND BETASUMMARY
APPENDIX 13A: Example of Computing Downside Beta Estimates
INTRODUCTIONCOMPUTING DOWNSIDE BETA ESTIMATES
CHAPTER 14: Size Effect 1
INTRODUCTIONSIZE AS A PREDICTOR OF EQUITY RETURNSTHE SIZE EFFECT: EMPIRICAL EVIDENCE FROM MORNINGSTAR AND DUFF & PHELPS STUDIESMORNINGSTAR STUDIESDUFF & PHELPS STUDIESESTIMATING SIZE PREMIA FOR A NONPUBLIC COMPANYSUMMARY
CHAPTER 15: Criticisms of the Size Effect 1
INTRODUCTIONIS THE SIZE EFFECT THE RESULT OF INCORRECTLY MEASURING BETAS?COMPOSITION OF THE SMALLEST SBBI VALUATION YEARBOOK DECILECOMPOSITION OF THE SMALLEST RISKPREMIUM REPORT PORTFOLIODATA ISSUESRISKS OF SMALL COMPANIESTHE SIZE EFFECT WITH BOOM YEARS OMITTEDIS THE SIZE EFFECT LIMITED TO ONLY THE SMALLEST COMPANIES?HAS THE SIZE EFFECT DISAPPEARED IN MORE RECENT PERIODS?SHOULD THE COST OF EQUITY CAPITAL USE A CHANGING SIZE PREMIUM?RELATIONSHIP OF SIZE AND MEASURES OF RISKRELATIONSHIP OF SIZE AND LIQUIDITYSUMMARY
APPENDIX 15A: Other Data Issues Regarding the Size Effect 1
SEASONALITYBID/ASK BOUNCE BIASDELISTING BIASTRANSACTION COSTS
CHAPTER 16: Company-specific Risk 1
INTRODUCTIONMATCHING RISK AND RETURNRISK DIFFERENCES OFTEN CANNOT BE ADJUSTED FOR IN NET CASH FLOWSMATCHING FUNDAMENTAL RISK AND RETURNMARKET PRICING OF OTHER COMPANY-SPECIFIC RISK FACTORSCOST TO CUREOTHER COMPANY-SPECIFIC FACTORSBIAS IN PROJECTIONSFRAMEWORKS FOR ANALYZING COMPANY-SPECIFIC RISKSUMMARY
CHAPTER 17: Distressed Businesses
INTRODUCTIONWHAT IS DISTRESS?VALUING FIRMS IN DISTRESSBANKRUPTCY PREDICTION MODELSCOST OF CAPITAL FOR DISTRESSED FIRMSVALUING COMPANIES EMERGING FROM BANKRUPTCYCOST OF DISTRESSSUMMARYADDITIONAL READING
APPENDIX 17A: Cost of Capital and the Valuation of Worthless Stock 1
INTRODUCTIONLIQUIDATING VALUEPOTENTIAL VALUEEXAMPLEPOSSIBILITY THAT VALUE OF THE BUSINESS ENTERPRISE EXCEEDS THE FACE VALUE OF DEBT—PRICING EQUITY AS A CALL OPTIONPOTENTIAL FUTURE VALUE: PROBABILITY THAT VALUE OF THE BUSINESS ENTERPRISE EXCEEDS THE FACE VALUE OF DEBTADDITIONAL CONSIDERATIONSSUMMARY
CHAPTER 18: Other Methods of Estimating the Cost of Equity Capital 1
INTRODUCTIONFAMA-FRENCH THREE-FACTOR MODELCOMPARING MODELSARBITRAGE PRICING THEORYMARKET-DERIVED CAPITAL PRICING MODELYIELD SPREAD MODELIMPLIED COST OF EQUITY CAPITALUSING ANALYST'S FORECASTSSOURCES OF INFORMATIONSUMMARYADDITIONAL READING
CHAPTER 19: Using the Duff & Phelps Risk Premium Report Data 1
INTRODUCTION 2HISTORY OF THE RISK PREMIUM REPORTORGANIZATIONDATA SOURCES AND COMPANIES INCLUDEDPERIOD ANALYZEDSIZE STUDY AND RISK STUDY PORTFOLIOSSIZE STUDYRISK STUDYHIGH-FINANCIAL-RISK STUDY“C” EXHIBITSSUMMARY
APPENDIX 19A: Examples Using the Duff & Phelps Risk Premium Report Data 1
USING THE RISK PREMIUM REPORT 2USING THE SIZE STUDY —EXAMPLESUSING THE “C” EXHIBITS—EXAMPLESUSING THE HIGH-FINANCIAL-RISK EXHIBITS
PART Three: Estimating the Overall Cost of Capital
CHAPTER 20: Other Components of a Business's Capital Structure
INTRODUCTIONDEBT CAPITALPREFERRED EQUITY CAPITALCONVERTIBLE DEBT AND CONVERTIBLE PREFERRED EQUITY CAPITALEMPLOYEE STOCK OPTIONSOBLIGATIONS THAT ARE SUBTRACTED IN A VALUATIONSUMMARYADDITIONAL READING
CHAPTER 21: Weighted Average Cost of Capital 1
INTRODUCTIONWHERE DOES WACC COME FROM?WHEN TO USE WACCVALUING THE LEVERED BUSINESS ENTERPRISEAFTER-TAX WACCDEBT CAPACITY AND OPTIMAL CAPITAL STRUCTURECOMPUTING WACC FOR A PUBLIC COMPANYCOMPUTING WACC FOR A NONPUBLIC COMPANYSHOULD AN ACTUAL OR A HYPOTHETICAL CAPITAL STRUCTURE BE USED?SHOULD A CONSTANT OR VARIABLE CAPITAL STRUCTURE BE USED?FIXED BOOK-VALUE LEVERAGE RATIOPRE-INTEREST-TAX-SHIELD WACCOTHER TAX SHIELDSSUMMARYADDITIONAL READING
APPENDIX 21A: Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital 1
INTRODUCTIONCAPITAL ASSET PRICING MODEL AND BETASOLUTION: THE ITERATIVE PROCESSPART 1: VALUE THE FIRM WITH CONSTANT CAPITAL STRUCTURE 5ASSUMPTIONS INHERENT IN WEIGHTED AVERAGE COST OF CAPITALSOLUTION: ITERATIVE PROCESS WITH CHANGING CAPITAL STRUCTUREPART 2: VALUE THE FIRM WITH CHANGING CAPITAL STRUCTURE 9SUMMARYADDITIONAL READING
PART Four: Estimating the Cost of Capital—Non-Freely Traded Interests
CHAPTER 22: Handling Discounts for Lack of Marketability and Liquidity for Minority Interests in Operating Businesses 1
INTRODUCTIONDISCRETE PERCENTAGE DISCOUNT FOR LACK OF MARKETABILITYUSING OPTIONS TO ESTIMATE THE DISCOUNT FOR LACK OF MARKETABILITYBUILDING THE DISCOUNT FOR LACK OF MARKETABILITY INTO THE DISCOUNT RATEMEASURING BLOCKAGE (LIQUIDITY) DISCOUNTS FOR PUBLIC COMPANIESSUMMARY
CHAPTER 23: Cost of Capital of Family Holding Company Interests
INTRODUCTIONFAMILY HOLDING COMPANYRELATIONSHIPS BETWEEN TIME TO A LIQUIDITY EVENT AND VALUELACK OF CONTROLESTIMATING THE COST OF ILLIQUIDITYILLIQUIDITY THEORYEMPIRICAL STUDIES ON EMBEDDED ILLIQUIDITYMeasuring Illiquidity from Market DataSUMMARY
CHAPTER 24: The Private Company Discount for Operating Businesses
INTRODUCTIONRELATIONSHIP BETWEEN DLOM FOR MINORITY INTERESTS AND PCDQUANTIFYING THE PRIVATE COMPANY DISCOUNTREASONS FOR THE PRIVATE COMPANY DISCOUNTSUMMARY
CHAPTER 25: Cost of Capital of Interests in Pass-through Entities
INTRODUCTIONCHARACTERISTICS OF PTEsGROSS DECISIONDELAWARE COURT ADJUSTS FOR TAX DIFFERENCESFAMILY LAW COURT ADJUSTS FOR TAX DIFFERENCESMARKET EVIDENCE OF VALUE OF INTERESTS IN PTEsCOST OF CAPITAL FOR PTEsRISKS OF INVESTMENTS IN PTEsSUMMARYADDITIONAL READING
CHAPTER 26: Relationship between Risk and Returns in Venture Capital and Private Equity Investments
INTRODUCTIONRETURNS ON VENTURE AND PRIVATE EQUITY FUNDSVENTURE CAPITAL INVESTMENTSPRIVATE EQUITY INVESTMENTSSUMMARYADDITIONAL READING
CHAPTER 27: Cost of Capital for Closely Held Businesses
INTRODUCTIONTHE CAPITAL MARKETSCOST OF CAPITAL SURVEYSUSING PRIVATE CAPITAL MARKETS DATATOTAL BETASUMMARY
PART Five: Corporate Finance Officers: Using Cost of Capital Data
CHAPTER 28: Capital Budgeting and Feasibility Studies
INTRODUCTIONINVEST FOR RETURNS ABOVE COST OF CAPITALDCF IS BEST CORPORATE DECISION MODELFOCUS ON NET CASH FLOWCAPITAL CASH FLOW AND ADJUSTED PRESENT VALUE METHODSUSE TARGET CAPITAL STRUCTURE OVER LIFE OF PROJECTSUMMARYADDITIONAL READING
CHAPTER 29: Cost of Capital for Divisions and Reporting Units 1
INTRODUCTIONDIVISIONAL COST OF CAPITALREPORTING UNIT COST OF CAPITALGOODWILL IMPAIRMENT—COST OF CAPITAL UNDER IFRSSUMMARYADDITIONAL READING
CHAPTER 30: Cost of Capital for Fair Value Reporting of Intangible Assets 1
INTRODUCTIONFINANCIAL REPORTING CONTEXTFAIR VALUE BALANCE SHEETINTANGIBLE ASSET INCOME APPROACHDIFFERENTIATING RISKS AMONG ASSETSIMPLIED RATE OF RETURN—UNIDENTIFIABLE INTANGIBLE ASSETSLIABILITIESSUMMARYADDITIONAL READING
CHAPTER 31: Cost of Capital in Evaluating Mergers and Acquisitions
INTRODUCTIONMIXED RESULTS FROM M&A TRANSACTIONSINVEST FOR RETURNS IN EXCESS OF THE COST OF CAPITALDCF IS THE BEST CORPORATE DECISION MODELFOCUS ON CASH FLOWSCATEGORIES OF CASH FLOWSESTIMATING THE COST OF CAPITALVALUE AND PRICE DIFFERIMPACT OF RECENT MARKET CONDITIONSCONTINGENT CONSIDERATIONCOMMON MISTAKESSUMMARY
CHAPTER 32: Cost of Capital in Transfer Pricing
INTRODUCTIONTAX TRANSFER PRICINGCOST OF CAPITAL ESTIMATES IN TRANSFER PRICINGCOST OF CAPITAL ESTIMATERELATING VALUATION OF ACQUIRED INTANGIBLE ASSETS FOR TRANSFER PRICING TO FINANCIAL REPORTING (ASC 805)THE ROLE OF CAPITAL IN TRANSFER PRICING FOR FINANCIAL SERVICES FIRMS: SPECIAL FOCUS ON GLOBAL DEALING OPERATIONSCONCLUSION
APPENDIX 32A: Cost of Capital in Transfer Pricing Example 1
CHAPTER 33: The Role of the Cost of Capital in EVA and in Corporate Value-Based Management
INTRODUCTIONHOW TO SCORE THE BUSINESS GAMEPRACTICAL INNOVATIONS ARE HELPINGBEST-PRACTICE EVA
PART Six: Other Cost of Capital Considerations
CHAPTER 34: Estimating Economic Income
INTRODUCTIONALTERNATIVE NET CASH FLOW FORMULASFINANCIAL ANALYSIS OF HISTORICAL OPERATING RESULTSREVENUE AND PROFITABILITY ESTIMATESNONCASH CHARGES AND INVESTMENTS IN FIXED ASSETSINVESTMENTS IN NET WORKING CAPITALREASONABLENESS OF ESTIMATED PROFIT MARGINS AND ASSET TURNOVERSTESTING NET CASH FLOW ESTIMATESESTIMATING ALTERNATIVE NET CASH FLOWSTERMINAL VALUE MODEL CONSIDERATIONSSUMMARYADDITIONAL READING
CHAPTER 35: Minority versus Control Implications of Cost of Capital Data
INTRODUCTIONMINORITY VERSUS CONTROL HAS LITTLE OR NO IMPACT ON COST OF CAPITALCOMPANY EFFICIENCY VERSUS OWNER EXPLOITATIONIMPACT OF THE STANDARD OF VALUEUNDER WHAT CIRCUMSTANCES SHOULD A CONTROL PREMIUM BE APPLIED?A TALE OF TWO MARKETSMANY TAKEOVERS AT LESS THAN PUBLIC TRADING PRICESUMMARY
CHAPTER 36: How Cost of Capital Relates to the Excess Earnings Method of Valuation
INTRODUCTIONBASIC “EXCESS EARNINGS” VALUATION METHODCOST OF CAPITAL REASONABLENESS CHECKVAGARIES OF THE EXCESS EARNINGS METHODSUMMARY
CHAPTER 37: Adjusting the Discount Rate to Alternative Economic Income Measures
INTRODUCTIONCONVERTING FROM CAPITALIZING NET CASH FLOW TO CAPITALIZING ANOTHER ECONOMIC INCOME MEASURECONVERTING AFTER-TAX RATES WITH ZERO OR CONSTANT GROWTHCONVERTING AFTER-TAX RATES WITH CHANGING GROWTHSUMMARYADDITIONAL READING
PART Seven: Considerations in Special Applications
CHAPTER 38: How Courts View Cost of Capital 1
APPRAISAL AND FAIRNESS CASES 2Discounted Cash Flow in Delaware LawESTATE AND GIFT TAX MATTERS 99DAMAGES FOR LOST PROFITS 132COST OF CAPITAL IN INTELLECTUAL PROPERTY DISPUTES 155BANKRUPTCY 217FAMILY LAW 339CORPORATE RESTRUCTURING AND OTHER FEDERAL TAX MATTERS 356AD VALOREM TAXES 383REGULATED INDUSTRIES 394
CHAPTER 39: Global Cost of Capital Models 1
INTRODUCTIONRISKSCOST OF EQUITY CAPITAL MODELSMODIFIED MODELSSHOULD PROJECTED NET CASH FLOWS AND THE COST OF CAPITAL BE NOMINAL OR REAL?CAPITAL STRUCTURESUMMARYADDITIONAL READING
CHAPTER 40: Cost of Capital of Real Property—Individual Assets 1
INTRODUCTIONTYPICAL STRUCTURE OF A REAL ESTATE TRANSACTIONREAL PROPERTY COMPETES WITH OTHER ASSET CLASSESDIRECT CAPITALIZATION METHODDISCOUNTED CASH FLOW METHODESTIMATING THE PROPERTY DISCOUNT RATESUMMARY
APPENDIX 40A: Valuing Real Property 1
INTRODUCTIONSTEPS IN ESTIMATING REAL PROPERTY VALUEDETERMINING THE PROJECTION (CAPITAL RECOVERY OR HOLDING) PERIODPROJECTING CASH FLOWSSUMMARY
CHAPTER 41: Cost of Capital of Real Estate Entities 1
INTRODUCTIONDEFINITION OF A REAL ESTATE ENTITYMEASURING NET CASH FLOW FOR REAL ESTATE ENTITIESVALUATION OF REAL ESTATE ENTITIESESTIMATING THE COST OF CAPITALSUMMARYADDITIONAL READING
APPENDIX 41A: Valuing Real Estate Entities 1
INTRODUCTIONMEASURING NET CASH FLOW FOR REAL ESTATE ENTITIESPROJECTED CASH FLOW FROM REAL ESTATE OPERATIONSPROJECTED NET CASH FLOW FOR REAL ESTATE ENTITYFUNDS FROM OPERATIONS AND ADJUSTED FUNDS FROM OPERATIONS
PART Eight: Case Studies
CHAPTER 42: Cost of Capital for a Mid-Sized Company 1
CASE BACKGROUNDVALUATION PROCEDURESCOST OF CAPITALCONTINGENT LIABILITIESCONCLUSION
APPENDIX 42A: Report for Cost of Capital for a Mid-Sized Company 1
SECTION C—LIABILITIES OF ABC OPCO AND RE HOLDCOSECTION E—COST OF CAPITAL OF ABC OPCOSECTION H—LEASED-FEE INTEREST VALUATION OF RE HOLDCO BUILDINGS
CHAPTER 43: Cost of Capital for a Smaller-Sized Company 1
CASE BACKGROUNDVALUATION PROCEDURESCOST OF EQUITY CAPITALCONCLUSION
APPENDIX 43A: Report for Cost of Capital for a Smaller-Sized Company
SECTION D—INCOME APPROACH
PART Nine: Advice to Practitioners
CHAPTER 44: Common Errors in Estimation and Use of Cost of Capital
INTRODUCTIONCONFUSING DISCOUNT RATES WITH CAPITALIZATION RATESSUBSTITUTING EBITDA FOR NET CASH FLOWUSING BOTH THE DISCOUNTING AND CAPITALIZING METHODS AND WEIGHTING THEMUSING THE FIRM'S COST OF CAPITAL TO EVALUATE A MORE OR LESS RISKY ACQUISITION OR PROJECTMISTAKING HISTORICAL RATES OF RETURN FOR EXPECTED RATES OF RETURNBLINDLY ACCEPTING MORNINGSTAR'S LONG-TERM AVERAGE AS TODAY'S EQUITY RISK PREMIUMUSING AN INCONSISTENT EQUITY RISK PREMIUM ESTIMATE TO THAT USED IN THE INDUSTRY RISK PREMIUMUSING AN INAPPROPRIATE BETA IN THE CAPMUSING AN INAPPROPRIATE BETA IN A MULTIFACTOR MODELUSING A SAFE RATE TO DISCOUNT OR CAPITALIZE A RISKY RETURNMISMATCHING THE DISCOUNT RATE WITH THE ECONOMIC INCOME MEASUREDISCOUNTING THE TERMINAL VALUE FOR N + 1 PERIODSSUBTRACTING A SHORT-TERM GROWTH RATE FROM THE DISCOUNT RATE TO GET A CAPITALIZATION RATEPERFORMING AN EXCESS EARNINGS METHOD VALUATION THAT RESULTS IN AN UNREALISTIC COST OF CAPITALINTERNALLY INCONSISTENT CAPITAL STRUCTURE PROJECTIONASSUMPTIONS THAT PRODUCE A STANDARD OF VALUE OTHER THAN THAT SPECIFIED IN THE VALUATION ENGAGEMENTUSING THE SAME WACC TO VALUE DIFFERENT BUSINESSES OWNED BY A DIVERSIFIED COMPANYINCORRECT OR INADEQUATELY SUPPORTED DATA IN ESTIMATING THE COST OF EQUITYPROJECTING GROWTH BEYOND THAT WHICH THE CAPITAL BEING VALUED WILL SUPPORTUSING AN UNATTAINABLE GROWTH RATE IN CALCULATING THE TERMINAL VALUEOTHER ERRORS IN ESTIMATING NET CASH FLOWSSUMMARY
CHAPTER 45: Advice on Dealing with Cost of Capital Issues
INTRODUCTIONPRACTICAL ISSUES AND ADVICESUMMARY
APPENDIX I: Bibliography
BOOKS AND OTHER PUBLICATIONSARTICLESWORKING PAPERS
APPENDIX II: Data Resources
MORNINGSTAR COST OF CAPITAL DATADUFF & PHELPS RISK PREMIUM REPORTBETASEARNINGS FORECASTS AND RELATED DATAPUBLICLY TRADED STOCK DATALARGER COMPANY MERGER AND ACQUISITION TRANSACTION SOURCESPRIVATE COMPANY SALE TRANSACTION DATAPARTNERSHIP TRANSACTION DATALACK OF MARKETABILITYINTEREST RATE DATAINTERNATIONAL RISKPERIODICALS
APPENDIX III: Glossary of Cost of Capital Terms
About the Website
APPENDICES
Index of Cases
Index

Content preview from Cost of Capital: Applications and Examples, + Website, 5th Edition

About the Authors

Cost of Capital Basics

CHAPTER 1

Defining Cost of Capital

CHAPTER 2

Introduction to Cost of Capital Applications: Valuation, Project Selection, and Ratemaking

CHAPTER 3

Net Cash Flow: The Preferred Measure of Economic Income

APPENDIX 3A

Alternative Measures of Economic Income

CHAPTER 4

Discounting versus Capitalizing

APPENDIX 4A

Equivalency of Capitalizing Residual Income

CHAPTER 5

Discounting—Beyond the Basics

CHAPTER 6

Relationship between Risk and the Cost of Capital

PART TWO

Estimating the Cost of Equity Capital

CHAPTER 7

Risk-free Rate

CHAPTER 8

Equity Risk Premium

APPENDIX 8A

Deriving ERP Estimates

APPENDIX 8B

Other Sources of ERP Estimates

CHAPTER 9

Build-up Method

CHAPTER 10

Capital Asset Pricing Model

CHAPTER 11

Beta: Differing Definitions and Estimates

APPENDIX 11A

Examples of Computing OLS Beta, Sum Beta, and Full-information Beta Estimates

APPENDIX 11B

Estimating Beta: Interpreting Regression Statistics

CHAPTER 12

Unlevering and Levering Equity Betas

CHAPTER 13

Criticism of CAPM and Beta versus Other Risk Measures

APPENDIX 13A

Example of Computing Downside Beta Estimates

CHAPTER 14

Size Effect

CHAPTER 15

Criticisms of the Size Effect

APPENDIX 15A

Other Data Issues Regarding the Size Effect

CHAPTER 16

Company-specific Risk

CHAPTER 17

Distressed Businesses

APPENDIX 17A

Cost of Capital and the Valuation of Worthless Stock ...

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Cost of Capital: Applications and Examples, + Website, 5th Edition

by Shannon P. Pratt, Roger J. Grabowski, Richard Brealey

Contents

Become an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
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