April 2014
Intermediate to advanced
1344 pages
44h 24m
English
book
Cost of Capital: Applications and Examples, + Website, 5th Edition
by Shannon P. Pratt, Roger J. Grabowski, Richard Brealey
Content preview from Cost of Capital: Applications and Examples, + Website, 5th Edition
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CHAPTER 29
Cost of Capital for Divisions and Reporting Units1
Carla Nunes
Estimating Divisional Cost of Equity Capital
Divisional Size as a Risk Measure
Reporting Unit Cost of Capital
Determining the Fair Value of Reporting Units
Testing Goodwill for Impairment
Measuring the Cost of Capital of Reporting Units
Reporting Unit Size as a Risk Measure
Goodwill Impairment—Cost of Capital under IFRS
Application of a Pretax or Post-Tax WACC
INTRODUCTION
In this chapter, we discuss the factors that affect the cost of capital of divisions and reporting units, with particular emphasis on the appropriate cost of capital for divisions and reporting units within an integrated firm.
Divisional cost of capital is important because, according to modern finance theory, the overall cost of capital for the firm is the weighted average cost of capital (WACC) for the businesses making up the company. The firm is viewed as a portfolio of businesses comprised of its divisions, with each such business or division having distinctive risk characteristics. You cannot simply apply the company's overall WACC to determine the value of each individual business, if the associated risk profiles are different.
Nor can you apply the company's overall cost of capital in making capital budgeting decisions. Since the risk of divisional ...
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