Cost of Capital: Applications and Examples, Fourth Edition
- 16h 41m
- Roger J. Grabowski, Shannon P. Pratt
- John Wiley & Sons (US)
- 2010
Cost of capital estimation has long been recognized as one of the most critical elements in business valuation, capital budgeting, feasibility studies, and corporate finance decisions and is also the most difficult procedure to assess and perform. Now in its fourth edition, Cost of Capital: Applications and Examples addresses the most controversial issues and problems in estimating the cost of capital.
Renowned valuation experts and authors Shannon Pratt and Roger Grabowski present both the theoretical development of cost of capital estimation and its practical application to valuation, capital budgeting, and forecasting of expected investment returns encountered in current practice. In this learning text/handy reference, Pratt and Grabowski deftly review and explore the theory of what drives the cost of capital, the models currently in use to estimate cost of capital, and the data available as inputs to the models to estimate cost of capital.
In this thoroughly updated and comprehensive fourth edition, Cost of Capital summarizes the results and practical implications of the latest research—much of which is gleaned from unpublished academic working papers—and includes scores of formulas and elucidating examples throughout to enhance readers' insights.
Pratt and Grabowski have updated their text to include a host of new material, including:
- A new chapter reconciling various forms of the income approach
- Expanded material on estimating the equity risk premium, chronicling the impact of the crisis of 2008–2010 and its impact on the cost of equity capital
- Expanded material on estimating the cost of debt capital and the impact of deleveraging on the debt capacity of businesses
- An updated chapter covering cost of capital for financial reporting under SFAS 141R, 142, and 144 (with full cross-referencing to the new FASB Accounting Codification), with examples of inferring rates of return for underlying assets from cost of capital of reporting units
- Expanded chapters on risk measures and their relationship to cost of capital and company-specific risk
- Expanded chapters on cost of capital for distressed companies
- Expanded discussions on the Morningstar SBBI data on supply-side equity risk premium and size premium
- Updated chapter on the cost of capital in transfer pricing related to the valuation of intangible assets under the new cost-sharing regulations
The landmark book corporate treasurers, business appraisers, CPAs, and valuation experts have come to rely on, Cost of Capital lays out the basic tools to use immediately when estimating cost of capital or when reviewing an estimate. This dynamic author team also analyzes criticism of major models for developing estimates of the cost of capital in use today, and also presents procedures for a number of alternative models.
This definitive text is an indispensable reference tool for professional valuation practitioners as well as attorneys and judges, investment bankers, CFOs, academicians and students, and CPAs.
About the Authors
Shannon P. Pratt, CFA, FASA, ARM, MCBA, CM&AA, referred to as the father of business valuations, is the author of several bestselling Wiley business valuation books and a sought-after speaker at business valuation industry conferences. He is the managing owner of Shannon Pratt Valuations, Inc., and has served as supervisory analyst for over 3,000 business valuation engagements in forty years and as an expert witness in numerous state and federal courts on contested business valuations.
Roger J. Grabowski is managing director of Duff & Phelps LLC. Roger has testified in court as an expert witness on the value of closely held businesses and business interests, matters of solvency, valuation, and amortization of intangible assets, and other valuation issues. He testified in the Northern Trust case, the first U.S. Tax Court decision that adopted the discounted cash flow method to value the stock of a closely held business with the discount rate based on the capital asset pricing model. Grabowski authors the annual Duff & Phelps Risk Premium Report.
In this Book
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Foreword
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Notation System and Abbreviations Used in This Book
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Defining Cost of Capital
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Introduction to Cost of Capital Applications—Valuation and Project Selection
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Net Cash Flow—Preferred Measure of Economic Income
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Discounting versus Capitalizing
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Relationship between Risk and the Cost of Capital
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Cost Components of a Business's Capital Structure
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Build-up Method
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Capital Asset Pricing Model
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Equity Risk Premium
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Beta—Differing Definitions and Estimates
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Unlevering and Levering Equity Betas
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Criticism of CAPM and Beta versus other Risk Measures
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Size Effect
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Criticisms of the Size Effect
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Company-Specific Risk
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Distressed Businesses
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Other Methods of Estimating the Cost of Equity Capital
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Weighted Average Cost of Capital
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Global Cost of Capital Models
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Using Morningstar Cost of Capital Data
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Capital Budgeting and Feasibility Studies
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Cost of Capital for Divisions and Reporting Units
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Cost of Capital for Fair Value Reporting of Intangible Assets
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Cost of Capital in Evaluating Mergers and Acquisitions
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Cost of Capital in Transfer Pricing
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Central Role of Cost of Capital in Economic Value Added
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Handling Discounts for Lack of Marketability and Liquidity for Minority Interests in Operating Businesses
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The Private Company Discount for Operating Businesses
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Cost of Capital of Interests in Pass-through Entities
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Relationship between Risk and Returns in Venture Capital and Private Equity Investments
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Minority versus Control Implications of Cost of Capital Data
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How Cost of Capital Relates to the Excess Earnings Method of Valuation
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Adjusting the Discount Rate to Alternative Economic Measures
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Estimating Net Cash Flows
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Common Errors in Estimation and Use of Cost of Capital
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Dealing with Cost of Capital Issues
