Valuation: Methods and Models in Applied Corporate Finance

5. Cost of Capital

5.1 Introduction

As stated in Chapter 1, “Introduction,” the primary goal of this book is to develop the methodology for measuring the value of any business decision, ranging from decisions such as going forward with a project (such as a new product introduction) or to acquisition decisions (such as purchasing another business). To do this, we need to evaluate the following present value relation:

where E(CF₁), E(CF₂), and so on are expected future cash flows, r denotes a discount rate, and Value₀ is the value of the project that we are trying to measure. Chapter 4, “Free Cash Flows,” discussed how the numerators in this formula ...