Cost of Capital: Applications and Examples / Edition 4by Shannon P. Pratt, Roger J. Grabowski
Pub. Date: 10/19/2010
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/i>
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 drivesthe 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Cost of Capital summarizes the results and practical implications of the latest research—much of which is gleaned from unpublished academic working papers—and includes scores of formulas and elucidating examples throughout to enhance readers' insights.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.
Table of Contents
About the Authors.
Notation System and Abbreviations Used in This Book.
Part One Cost of Capital Basics.
Chapter 1 Defining Cost of Capital.
Chapter 2 Introduction to Cost of Capital Applications: Valuation and Project Selection.
Chapter 3 Net Cash Flow: Preferred Measure of Economic Income.
Chapter 4 Discounting versus Capitalizing.
Chapter 5 Relationship between Risk and the Cost of Capital.
Chapter 6 Cost Components of a Business's Capital Structure.
Part Two Estimating the Cost of Equity Capital and the Overall Cost of Capital.
Chapter 7 Build-up Method.
Chapter 8 Capital Asset Pricing Model.
Chapter 9 Equity Risk Premium.
Appendix 9A Realized Risk Premium (ex Post) Approach.
Chapter 10 Beta: Differing Definitions and Estimates.
Chapter 11 Unlevering and Levering Equity Betas.
Chapter 12 Criticism of CAPM and Beta versus Other Risk Measures.
Chapter 13 Size Effect.
Chapter 14 Criticisms of the Size Effect.
Appendix 14A Other Data Issues Regarding the Size Effect.
Chapter 15 Company-Specific Risk.
Chapter 16 Distressed Businesses.
Chapter 17 Other Methods of Estimating the Cost of Equity Capital.
Chapter 18 Weighted Average Cost of Capital.
Chapter 19 Global Cost of Capital Models.
Chapter 20 Using Morningstar Cost of Capital Data
Part Three Corporate Finance Officers: Using Cost of Capital Data.
Chapter 21 Capital Budgeting and Feasibility Studies.
Chapter 22 Cost of Capital for Divisions and Reporting Units.
Chapter 23 Cost of Capital for Fair Value Reporting of Intangible Assets.
Chapter 24 Cost of Capital in Evaluating Mergers and Acquisitions.
Chapter 25 Cost of Capital in Transfer Pricing.
Chapter 26 Central Role of Cost of Capital in Economic Value Added.
Part Four Other Cost of Capital Considerations.
Chapter 27 Handling Discounts for Lack of Marketability and Liquidity for Minority Interests in Operating Businesses.
Chapter 28 The Private Company Discount for Operating Businesses.
Chapter 29 Cost of Capital of Interests in Pass-Through Entities.
Chapter 30 Relationship between Risk and Returns in Venture Capital and Private Equity Investments.
Chapter 31 Minority versus Control Implications of Cost of Capital Data.
Chapter 32 How Cost of Capital Relates to the Excess Earnings Method of Valuation.
Chapter 33 Adjusting the Discount Rate to Alternative Economic Measures.
Chapter 34 Estimating Net Cash Flows.
Part Five Advice to Practitioners.
Chapter 35 Common Errors in Estimation and Use of Cost of Capital.
Chapter 36 Dealing with Cost of Capital Issues.
Appendix I Bibliography.
Appendix II Data Sources.
Appendix III International Glossary of Business Valuation Terms.
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