Cost of Capital

About the Authors xiii Foreword xxiii Preface xxv Acknowledgments xxix PART ONE Cost of Capital Basics 1 CHAPTER 1 Defining Cost of Capital 3 CHAPTER 2 Introduction to Cost of Capital Applications: Valuation, Project Selection, and Ratemaking 11 CHAPTER 3 Net Cash Flow: The Preferred Measure of Economic Income 17 APPENDIX 3A Alternative Measures of Economic Income 30 CHAPTER 4 Discounting versus Capitalizing 36 APPENDIX 4A Equivalency of Capitalizing Residual Income 56 CHAPTER 5 Discounting—Beyond the Basics 60 CHAPTER 6 Relationship between Risk and the Cost of Capital 70 PART TWO Estimating the Cost of Equity Capital 89 CHAPTER 7 Risk-free Rate 91 CHAPTER 8 Equity Risk Premium 110 APPENDIX 8A Deriving ERP Estimates 141 APPENDIX 8B Other Sources of ERP Estimates 173 CHAPTER 9 Build-up Method 177 CHAPTER 10 Capital Asset Pricing Model 189 CHAPTER 11 Beta: Differing Definitions and Estimates 202 APPENDIX 11A Examples of Computing OLS Beta, Sum Beta, and Full-information Beta Estimates 225 APPENDIX 11B Estimating Beta: Interpreting Regression Statistics 234 CHAPTER 12 Unlevering and Levering Equity Betas 243 CHAPTER 13 Criticism of CAPM and Beta versus Other Risk Measures 269 APPENDIX 13A Example of Computing Downside Beta Estimates 298 CHAPTER 14 Size Effect 301 CHAPTER 15 Criticisms of the Size Effect 331 APPENDIX 15A Other Data Issues Regarding the Size Effect 363 CHAPTER 16 Company-specific Risk 372 CHAPTER 17 Distressed Businesses 400 APPENDIX 17A Cost of Capital and the Valuation of Worthless Stock 428 CHAPTER 18 Other Methods of Estimating the Cost of Equity Capital 444 CHAPTER 19 Using the Duff & Phelps Risk Premium Report Data 471 APPENDIX 19A Examples Using the Duff & Phelps Risk Premium Report Data 499 PART THREE Estimating the Overall Cost of Capital 519 CHAPTER 20 Other Components of a Business's Capital Structure 521 CHAPTER 21 Weighted Average Cost of Capital 544 APPENDIX 21A Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital 576 PART FOUR Estimating the Cost of Capital—Non-Freely Traded Interests 609 CHAPTER 22 Handling Discounts for Lack of Marketability and Liquidity for Minority Interests in Operating Businesses 611 CHAPTER 23 Cost of Capital of Family Holding Company Interests 630 CHAPTER 24 The Private Company Discount for Operating Businesses 650 CHAPTER 25 Cost of Capital of Interests in Pass-through Entities 663 CHAPTER 26 Relationship between Risk and Returns in Venture Capital and Private Equity Investments 680 CHAPTER 27 Cost of Capital for Closely Held Businesses 693 PART FIVE Corporate Finance Officers: Using Cost of Capital Data 711 CHAPTER 28 Capital Budgeting and Feasibility Studies 713 CHAPTER 29 Cost of Capital for Divisions and Reporting Units 722 CHAPTER 30 Cost of Capital for Fair Value Reporting of Intangible Assets 757 CHAPTER 31 Cost of Capital in Evaluating Mergers and Acquisitions 779 CHAPTER 32 Cost of Capital in Transfer Pricing 793 APPENDIX 32A Cost of Capital in Transfer Pricing Example 822 CHAPTER 33 The Role of the Cost of Capital in EVA and in Corporate Value-Based Management 825 PART SIX Other Cost of Capital Considerations 839 CHAPTER 34 Estimating Economic Income 841 CHAPTER 35 Minority versus Control Implications of Cost of Capital Data 861 CHAPTER 36 How Cost of Capital Relates to the Excess Earnings Method of Valuation 873 CHAPTER 37 Adjusting the Discount Rate to Alternative Economic Income Measures 881 PART SEVEN Considerations in Special Applications 897 CHAPTER 38 How Courts View Cost of Capital 899 CHAPTER 39 Global Cost of Capital Models 1011 CHAPTER 40 Cost of Capital of Real Property—Individual Assets 1052 APPENDIX 40A Valuing Real Property 1076 CHAPTER 41 Cost of Capital of Real Estate Entities 1084 APPENDIX 41A Valuing Real Estate Entities 1122 PART EIGHT Case Studies 1129 CHAPTER 42 Cost of Capital for a Mid-Sized Company 1131 APPENDIX 42A Report for Cost of Capital for a Mid-Sized Company 1138 CHAPTER 43 Cost of Capital for a Smaller-Sized Company 1162 APPENDIX 43A Report for Cost of Capital for a Smaller-Sized Company 1168 PART NINE Advice to Practitioners 1179 CHAPTER 44 Common Errors in Estimation and Use of Cost of Capital 1181 CHAPTER 45 Advice on Dealing with Cost of Capital Issues 1199 APPENDIX I Bibliography 1213 APPENDIX II Data Resources 1239 APPENDIX III Glossary of Cost of Capital Terms 1253 About the Website 1266 Index of Cases 1267 Index 1271