Book description
A one-stop shop for background and current thinking on the development and uses of rates of return on capital
Completely revised for this highly anticipated fifth edition, Cost of Capital contains expanded materials on estimating the basic building blocks of the cost of equity capital, the risk-free rate, and equity risk premium. There is also discussion of the volatility created by the financial crisis in 2008, the subsequent recession and uncertain recovery, and how those events have fundamentally changed how we need to interpret the inputs to the models we use to develop these estimates.
The book includes new case studies providing comprehensive discussion of cost of capital estimates for valuing a business and damages calculations for small and medium-sized businesses, cross-referenced to the chapters covering the theory and data.
Addresses equity risk premium and the risk-free rate, including the impact of Federal Reserve actions
Explores how to use Morningstar's Ibbotson and Duff Phelps Risk Premium Report data
Discusses the global cost of capital estimation, including a new size study of European countries
Cost of Capital, Fifth Edition puts an emphasis on practical application. To that end, this updated edition provides readers with exclusive access to a companion website filled with supplementary materials, allowing you to continue to learn in a hands-on fashion long after closing the book.
Table of contents
- Cover Page
- Title Page
- Copyright
- Dedication
- Contents
- About the Author
- Foreword
- Preface
- Acknowledgments
-
PART One: Cost of Capital Basics
-
CHAPTER 1: Defining Cost of Capital
- INTRODUCTION
- COMPONENTS OF A CAPITAL STRUCTURE
- COST OF CAPITAL IS A FUNCTION OF THE INVESTMENT
- COST OF CAPITAL IS FORWARD-LOOKING
- COST OF CAPITAL IS BASED ON MARKET VALUE
- COST OF CAPITAL IS USUALLY STATED IN NOMINAL TERMS
- COST OF CAPITAL EQUALS THE DISCOUNT RATE
- DISCOUNT RATE IS NOT THE SAME AS CAPITALIZATION RATE
- STANDARD (BASIS) OF VALUE
- SUMMARY
- 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
- INTRODUCTION
- CAPITALIZATION FORMULA
- FUNCTIONAL RELATIONSHIP BETWEEN DISCOUNT RATE AND CAPITALIZATION RATE
- MAJOR DIFFERENCE BETWEEN DISCOUNTING AND CAPITALIZING
- CONSTANT GROWTH OR GORDON GROWTH MODEL
- CRITICISMS OF THE GORDON GROWTH MODEL
- COMBINING DISCOUNTING AND CAPITALIZING
- EQUIVALENCY OF DISCOUNTING AND CAPITALIZING MODELS
- SUMMARY
- APPENDIX 4A: Equivalency of Capitalizing Residual Income
- CHAPTER 5: Discounting—Beyond the Basics
- CHAPTER 6: Relationship between Risk and the Cost of Capital
-
CHAPTER 1: Defining Cost of Capital
-
PART TWO: Estimating the Cost of Equity Capital
- INTRODUCTION
- CHAPTER 7: Risk-free Rate 1
- CHAPTER 8: Equity Risk Premium 1
- APPENDIX 8A: Deriving ERP Estimates 1
- APPENDIX 8B: Other Sources of ERP Estimates
- CHAPTER 9: Build-up Method
-
CHAPTER 10: Capital Asset Pricing Model
- INTRODUCTION
- CONCEPT OF MARKET OR SYSTEMATIC RISK
- BACKGROUND OF THE CAPITAL ASSET PRICING MODEL
- MARKET (OR SYSTEMATIC) AND UNIQUE (OR UNSYSTEMATIC) RISKS
- USING BETA TO ESTIMATE EXPECTED RATE OF RETURN
- MODIFYING CAPM
- MODIFIED CAPM COST OF CAPITAL FORMULA
- EXAMPLES OF A CAPM MODEL
- ASSUMPTIONS UNDERLYING THE CAPITAL ASSET PRICING MODEL
- SUMMARY
- CHAPTER 11: Beta: Differing Definitions and Estimates 1
- 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 1
- CHAPTER 13: Criticism of CAPM and Beta versus Other Risk Measures 1
- APPENDIX 13A: Example of Computing Downside Beta Estimates
- CHAPTER 14: Size Effect 1
-
CHAPTER 15: Criticisms of the Size Effect 1
- INTRODUCTION
- IS THE SIZE EFFECT THE RESULT OF INCORRECTLY MEASURING BETAS?
- COMPOSITION OF THE SMALLEST SBBI VALUATION YEARBOOK DECILE
- COMPOSITION OF THE SMALLEST RISKPREMIUM REPORT PORTFOLIO
- DATA ISSUES
- RISKS OF SMALL COMPANIES
- THE SIZE EFFECT WITH BOOM YEARS OMITTED
- IS 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 RISK
- RELATIONSHIP OF SIZE AND LIQUIDITY
- SUMMARY
- APPENDIX 15A: Other Data Issues Regarding the Size Effect 1
-
CHAPTER 16: Company-specific Risk 1
- INTRODUCTION
- MATCHING RISK AND RETURN
- RISK DIFFERENCES OFTEN CANNOT BE ADJUSTED FOR IN NET CASH FLOWS
- MATCHING FUNDAMENTAL RISK AND RETURN
- MARKET PRICING OF OTHER COMPANY-SPECIFIC RISK FACTORS
- COST TO CURE
- OTHER COMPANY-SPECIFIC FACTORS
- BIAS IN PROJECTIONS
- FRAMEWORKS FOR ANALYZING COMPANY-SPECIFIC RISK
- SUMMARY
- CHAPTER 17: Distressed Businesses
-
APPENDIX 17A: Cost of Capital and the Valuation of Worthless Stock 1
- INTRODUCTION
- LIQUIDATING VALUE
- POTENTIAL VALUE
- EXAMPLE
- POSSIBILITY THAT VALUE OF THE BUSINESS ENTERPRISE EXCEEDS THE FACE VALUE OF DEBT—PRICING EQUITY AS A CALL OPTION
- POTENTIAL FUTURE VALUE: PROBABILITY THAT VALUE OF THE BUSINESS ENTERPRISE EXCEEDS THE FACE VALUE OF DEBT
- ADDITIONAL CONSIDERATIONS
- SUMMARY
- CHAPTER 18: Other Methods of Estimating the Cost of Equity Capital 1
- CHAPTER 19: Using the Duff & Phelps Risk Premium Report Data 1
- APPENDIX 19A: Examples Using the Duff & Phelps Risk Premium Report Data 1
-
PART Three: Estimating the Overall Cost of Capital
- CHAPTER 20: Other Components of a Business's Capital Structure
-
CHAPTER 21: Weighted Average Cost of Capital 1
- INTRODUCTION
- WHERE DOES WACC COME FROM?
- WHEN TO USE WACC
- VALUING THE LEVERED BUSINESS ENTERPRISE
- AFTER-TAX WACC
- DEBT CAPACITY AND OPTIMAL CAPITAL STRUCTURE
- COMPUTING WACC FOR A PUBLIC COMPANY
- COMPUTING WACC FOR A NONPUBLIC COMPANY
- SHOULD AN ACTUAL OR A HYPOTHETICAL CAPITAL STRUCTURE BE USED?
- SHOULD A CONSTANT OR VARIABLE CAPITAL STRUCTURE BE USED?
- FIXED BOOK-VALUE LEVERAGE RATIO
- PRE-INTEREST-TAX-SHIELD WACC
- OTHER TAX SHIELDS
- SUMMARY
- ADDITIONAL READING
-
APPENDIX 21A: Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital 1
- INTRODUCTION
- CAPITAL ASSET PRICING MODEL AND BETA
- SOLUTION: THE ITERATIVE PROCESS
- PART 1: VALUE THE FIRM WITH CONSTANT CAPITAL STRUCTURE 5
- ASSUMPTIONS INHERENT IN WEIGHTED AVERAGE COST OF CAPITAL
- SOLUTION: ITERATIVE PROCESS WITH CHANGING CAPITAL STRUCTURE
- PART 2: VALUE THE FIRM WITH CHANGING CAPITAL STRUCTURE 9
- SUMMARY
- ADDITIONAL 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
- CHAPTER 23: Cost of Capital of Family Holding Company Interests
- CHAPTER 24: The Private Company Discount for Operating Businesses
- CHAPTER 25: Cost of Capital of Interests in Pass-through Entities
- CHAPTER 26: Relationship between Risk and Returns in Venture Capital and Private Equity Investments
- CHAPTER 27: Cost of Capital for Closely Held Businesses
-
PART Five: Corporate Finance Officers: Using Cost of Capital Data
- CHAPTER 28: Capital Budgeting and Feasibility Studies
- CHAPTER 29: Cost of Capital for Divisions and Reporting Units 1
- CHAPTER 30: Cost of Capital for Fair Value Reporting of Intangible Assets 1
-
CHAPTER 31: Cost of Capital in Evaluating Mergers and Acquisitions
- INTRODUCTION
- MIXED RESULTS FROM M&A TRANSACTIONS
- INVEST FOR RETURNS IN EXCESS OF THE COST OF CAPITAL
- DCF IS THE BEST CORPORATE DECISION MODEL
- FOCUS ON CASH FLOWS
- CATEGORIES OF CASH FLOWS
- ESTIMATING THE COST OF CAPITAL
- VALUE AND PRICE DIFFER
- IMPACT OF RECENT MARKET CONDITIONS
- CONTINGENT CONSIDERATION
- COMMON MISTAKES
- SUMMARY
-
CHAPTER 32: Cost of Capital in Transfer Pricing
- INTRODUCTION
- TAX TRANSFER PRICING
- COST OF CAPITAL ESTIMATES IN TRANSFER PRICING
- COST OF CAPITAL ESTIMATE
- RELATING 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 OPERATIONS
- CONCLUSION
- 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
-
PART Six: Other Cost of Capital Considerations
-
CHAPTER 34: Estimating Economic Income
- INTRODUCTION
- ALTERNATIVE NET CASH FLOW FORMULAS
- FINANCIAL ANALYSIS OF HISTORICAL OPERATING RESULTS
- REVENUE AND PROFITABILITY ESTIMATES
- NONCASH CHARGES AND INVESTMENTS IN FIXED ASSETS
- INVESTMENTS IN NET WORKING CAPITAL
- REASONABLENESS OF ESTIMATED PROFIT MARGINS AND ASSET TURNOVERS
- TESTING NET CASH FLOW ESTIMATES
- ESTIMATING ALTERNATIVE NET CASH FLOWS
- TERMINAL VALUE MODEL CONSIDERATIONS
- SUMMARY
- ADDITIONAL READING
- CHAPTER 35: Minority versus Control Implications of Cost of Capital Data
- CHAPTER 36: How Cost of Capital Relates to the Excess Earnings Method of Valuation
- CHAPTER 37: Adjusting the Discount Rate to Alternative Economic Income Measures
-
CHAPTER 34: Estimating Economic Income
-
PART Seven: Considerations in Special Applications
-
CHAPTER 38: How Courts View Cost of Capital 1
- APPRAISAL AND FAIRNESS CASES 2
- Discounted Cash Flow in Delaware Law
- ESTATE AND GIFT TAX MATTERS 99
- DAMAGES FOR LOST PROFITS 132
- COST OF CAPITAL IN INTELLECTUAL PROPERTY DISPUTES 155
- BANKRUPTCY 217
- FAMILY LAW 339
- CORPORATE RESTRUCTURING AND OTHER FEDERAL TAX MATTERS 356
- AD VALOREM TAXES 383
- REGULATED INDUSTRIES 394
- CHAPTER 39: Global Cost of Capital Models 1
- CHAPTER 40: Cost of Capital of Real Property—Individual Assets 1
- APPENDIX 40A: Valuing Real Property 1
- CHAPTER 41: Cost of Capital of Real Estate Entities 1
- APPENDIX 41A: Valuing Real Estate Entities 1
-
CHAPTER 38: How Courts View Cost of Capital 1
- PART Eight: Case Studies
-
PART Nine: Advice to Practitioners
-
CHAPTER 44: Common Errors in Estimation and Use of Cost of Capital
- INTRODUCTION
- CONFUSING DISCOUNT RATES WITH CAPITALIZATION RATES
- SUBSTITUTING EBITDA FOR NET CASH FLOW
- USING BOTH THE DISCOUNTING AND CAPITALIZING METHODS AND WEIGHTING THEM
- USING THE FIRM'S COST OF CAPITAL TO EVALUATE A MORE OR LESS RISKY ACQUISITION OR PROJECT
- MISTAKING HISTORICAL RATES OF RETURN FOR EXPECTED RATES OF RETURN
- BLINDLY ACCEPTING MORNINGSTAR'S LONG-TERM AVERAGE AS TODAY'S EQUITY RISK PREMIUM
- USING AN INCONSISTENT EQUITY RISK PREMIUM ESTIMATE TO THAT USED IN THE INDUSTRY RISK PREMIUM
- USING AN INAPPROPRIATE BETA IN THE CAPM
- USING AN INAPPROPRIATE BETA IN A MULTIFACTOR MODEL
- USING A SAFE RATE TO DISCOUNT OR CAPITALIZE A RISKY RETURN
- MISMATCHING THE DISCOUNT RATE WITH THE ECONOMIC INCOME MEASURE
- DISCOUNTING THE TERMINAL VALUE FOR N + 1 PERIODS
- SUBTRACTING A SHORT-TERM GROWTH RATE FROM THE DISCOUNT RATE TO GET A CAPITALIZATION RATE
- PERFORMING AN EXCESS EARNINGS METHOD VALUATION THAT RESULTS IN AN UNREALISTIC COST OF CAPITAL
- INTERNALLY INCONSISTENT CAPITAL STRUCTURE PROJECTION
- ASSUMPTIONS THAT PRODUCE A STANDARD OF VALUE OTHER THAN THAT SPECIFIED IN THE VALUATION ENGAGEMENT
- USING THE SAME WACC TO VALUE DIFFERENT BUSINESSES OWNED BY A DIVERSIFIED COMPANY
- INCORRECT OR INADEQUATELY SUPPORTED DATA IN ESTIMATING THE COST OF EQUITY
- PROJECTING GROWTH BEYOND THAT WHICH THE CAPITAL BEING VALUED WILL SUPPORT
- USING AN UNATTAINABLE GROWTH RATE IN CALCULATING THE TERMINAL VALUE
- OTHER ERRORS IN ESTIMATING NET CASH FLOWS
- SUMMARY
- CHAPTER 45: Advice on Dealing with Cost of Capital Issues
-
CHAPTER 44: Common Errors in Estimation and Use of Cost of Capital
- APPENDIX I: Bibliography
-
APPENDIX II: Data Resources
- MORNINGSTAR COST OF CAPITAL DATA
- DUFF & PHELPS RISK PREMIUM REPORT
- BETAS
- EARNINGS FORECASTS AND RELATED DATA
- PUBLICLY TRADED STOCK DATA
- LARGER COMPANY MERGER AND ACQUISITION TRANSACTION SOURCES
- PRIVATE COMPANY SALE TRANSACTION DATA
- PARTNERSHIP TRANSACTION DATA
- LACK OF MARKETABILITY
- INTEREST RATE DATA
- INTERNATIONAL RISK
- PERIODICALS
- APPENDIX III: Glossary of Cost of Capital Terms
- About the Website
- Index of Cases
- Index
Product information
- Title: Cost of Capital: Applications and Examples, + Website, 5th Edition
- Author(s):
- Release date: April 2014
- Publisher(s): Wiley
- ISBN: 9781118555804
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