Cost of Capital: Applications and Examples PLUS Website, Fifth Edition

April 2014 978-1-118-55580-4 Hardcover (1,311 pages)

Shannon Pratt, Roger Grabowski

John Wiley & Sons, Inc.

Completely revised for this highly anticipated fifth edition, Cost of Capital contains expanded materials on estimating the basic building blocks of the cost of equity capital, the risk-free rate, and equity risk premium. There is also discussion of the volatility created by the financial crisis in 2008, the subsequent recession and uncertain recovery, and how those events have fundamentally changed how we need to interpret the inputs to the models we use to develop these estimates. 

The book includes new case studies providing comprehensive discussion of cost of capital estimates for valuing a business and damages calculations for small and medium-sized businesses, cross-referenced to the chapters covering the theory and data. 

  • Addresses equity risk premium and the risk-free rate, including the impact of Federal Reserve actions
  • Discusses the global cost of capital estimation, including a new size study of European countries

Cost of Capital, Fifth Edition puts an emphasis on practical application. To that end, this updated edition provides readers with exclusive access to a companion website filled with supplementary materials, allowing you to continue to learn in a hands-on fashion long after closing the book.

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Table of Contents

About the Authors

Part One: Cost of Capital Basics 
CHAPTER 1: Defining Cost of Capital 
CHAPTER 2: Introduction to Cost of Capital Applications: Valuation, Project Selection, and Ratemaking 
CHAPTER 3: Net Cash Flow: The Preferred Measure of Economic Income 
APPENDIX 3A: Alternative Measures of Economic Income 
CHAPTER 4: Discounting versus Capitalizing 
APPENDIX 4A: Equivalency of Capitalizing Residual Income 
CHAPTER 5: Discounting—Beyond the Basics 
CHAPTER 6: Relationship between Risk and the Cost of Capital

Part Two: Estimating the Cost of Equity Capital 
CHAPTER 7: Risk-free Rate 
CHAPTER 8: Equity Risk Premium 
APPENDIX 8A: Deriving ERP Estimates 
APPENDIX 8B: Other Sources of ERP Estimates 
CHAPTER 9: Build-up Method
CHAPTER 10: Capital Asset Pricing Model
CHAPTER 11: Beta: Differing Definitions and Estimates 
APPENDIX 11A: Examples of Computing OLS Beta, Sum Beta, and Full-information Beta Estimates 
APPENDIX 11B: Estimating Beta: Interpreting Regression Statistics 
CHAPTER 12: Unlevering and Levering Equity Betas
CHAPTER 13: Criticism of CAPM and Beta versus Other Risk Measures
APPENDIX 13A: Example of Computing Downside Beta Estimates
CHAPTER 14: Size Effect
CHAPTER 15: Criticisms of the Size Effect
APPENDIX 15A: Other Data Issues Regarding the Size Effect 
CHAPTER 16: Company-specific Risk 
CHAPTER 17: Distressed Businesses 
APPENDIX 17A: Cost of Capital and the Valuation of Worthless Stock 
CHAPTER 18: Other Methods of Estimating the Cost of Equity Capital 
CHAPTER 19: Using the Duff & Phelps Risk Premium Report Data 
APPENDIX 19A: Examples Using the Duff & Phelps Risk Premium Report Data

Part Three: Estimating the Overall Cost of Capital 
CHAPTER 20: Other Components of a Business's Capital Structure 
CHAPTER 21: Weighted Average Cost of Capital 
APPENDIX 21A: Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital

Part Four: Estimating the Cost of Capital—Non-Freely Traded Interests
CHAPTER 22: Handling Discounts for Lack of Marketability and Liquidity for Minority Interests in Operating Businesses 
CHAPTER 23: Cost of Capital of Family Holding Company Interests 
CHAPTER 24: The Private Company Discount for Operating Businesses
CHAPTER 25: Cost of Capital of Interests in Pass-through Entities 
CHAPTER 26: Relationship between Risk and Returns in Venture Capital and Private Equity Investments 
CHAPTER 27: Cost of Capital for Closely Held Businesses 693

Part Five: Corporate Finance Officers: Using Cost of Capital Data 
CHAPTER 28: Capital Budgeting and Feasibility Studies
CHAPTER 29: Cost of Capital for Divisions and Reporting Units
CHAPTER 30: Cost of Capital for Fair Value Reporting of Intangible Assets
CHAPTER 31: Cost of Capital in Evaluating Mergers and Acquisitions
CHAPTER 32: Cost of Capital in Transfer Pricing
APPENDIX 32A: Cost of Capital in Transfer Pricing Example
CHAPTER 33: The Role of the Cost of Capital in EVA and in Corporate Value-Based Management

Part Six: Other Cost of Capital Considerations
CHAPTER 34: Estimating Economic Income
CHAPTER 35: Minority versus Control Implications of Cost of Capital Data 
CHAPTER 36: How Cost of Capital Relates to the Excess Earnings Method of Valuation 
CHAPTER 37: Adjusting the Discount Rate to Alternative Economic Income Measures

Part Seven: Considerations in Special Applications 
CHAPTER 38: How Courts View Cost of Capital 
CHAPTER 39: Global Cost of Capital Models 
CHAPTER 40: Cost of Capital of Real Property—Individual Assets 
APPENDIX 40A: Valuing Real Property 
CHAPTER 41: Cost of Capital of Real Estate Entities 
APPENDIX 41A: Valuing Real Estate Entities

Part Eight: Case Studies
CHAPTER 42: Cost of Capital for a Mid-Sized Company 
APPENDIX 42A: Report for Cost of Capital for a Mid-Sized Company
CHAPTER 43: Cost of Capital for a Smaller-Sized Company
APPENDIX 43A: Report for Cost of Capital for a Smaller-Sized Company

Part Nine: Advice to Practitioners 
CHAPTER 44: Common Errors in Estimation and Use of Cost of Capital
CHAPTER 45: Advice on Dealing with Cost of Capital Issues

APPENDIX I: Bibliography 
APPENDIX II: Data Resources 
APPENDIX III: Glossary of Cost of Capital Terms 
About the Website 
Index of Cases