Knowledge about the magnitude of the cost of capital invested in an asset and its determinants is essential for the analysis of corporate investment decisions and for assessing profitability. This book provides a clear conceptual understanding of the cost of capital, the characteristics of an asset that influence it, and a critical, comprehensive, and up-to-date evaluation of practical means for estimating its magnitude. It is intended primarily for use by professional managers, but will also be valuable to future managers in advanced capital budgeting courses.
The focus of the discussion is on estimation methods that are theoretically sound and consistent with a corporate goal of value creation. Three methods are analyzed in depth: the discounted cash flow model, the capital asset pricing model, and arbitrage pricing theory. For each method, the basic theory is set out in a nontechnical manner and empirical evidence in support of the model is critically reviewed. The bulk of the discussion then focuses on practical means for implementing the methods for decision-making purposes. Later chapters focus on the effects of the debt-supporting characteristics of assets, on the valuation of options embedded in securities, and on the estimation of the cost of capital for evaluating international investments. The final chapter discusses certain aspects of the use of cost of capital in public utility regulation. Care is taken to separate out key issues from more peripheral material through a comprehensive set of supplementary notes.
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About the Author
CLEVELAND S. PATTERSON is Professor of Finance at Concordia University, Montreal and president of Cleveland S. Patterson and Associates, Ltd. Prior to beginning his academic career he was a senior officer and director of several major firms in the financial services and telecommunications industries, and during the past 20 years has provided consulting services to numerous government and corporate clients including Bell Canada, CP Rail, Syncrude Canada, the Canadian cable TV industry, and the Canadian Radio-television and Telecommunications Commission. He is the author of a large number of academic publications in financial journals and conference proceedings.
Table of Contents
The Concept and Uses of the Cost of Capital
Theoretical Models for Estimating the Cost of Equity Capital
Empirical Evidence on Validity of DCF Model and CAPM
Estimation of the Cost of Equity Using the DCF Model
Estimation of the Cost of Equity Using the CAPM
Arbitrage Pricing and Other Models for Estimating the Cost of Equity
Financing Effects and the Weighted Average Cost of Capital
Multi-Period Issues in Application of WACC Estimates
Estimating the Cost of Capital for Non-Traded Assets
The Cost of Capital for International Investments
Option Pricing Theory and the Cost of Capital
The Cost of Capital in Public Utility Regulation
Glossary of Notation and Abbreviations