Cost of Capital (PDF)

About the Authors. Acknowledgments. Introduction. Notation. Part I. Cost of Capital Basics. 1. Defining Cost of Capital 2. Introduction to Cost of Capital Applications: Valuation and Project Selection. 3. Net cash flow: The Preferred Measure of Return. 4. Discounting versus Capitalizing. 5. Relationship between Risk and Cost of Capital. 6. Cost Components of a Company's Capital Structure. 7. Weighted Average or Overall Cost of Capital. Appendix 7.1. Iterative Process Using CAPM to Calculate the Cost of Equity component of the Weighted Average Cost of Capital - Constant Capital Structure. Appendix7.2. Iterative process using CAPM to calculate the cost of Equity component of the weighted average cost of capital - changing capital structure. Part II. Estimating the Cost of Equity Capital "As If Publicly Traded". 8. Equity Risk Premium. 8.1 Appendix. 9. Build-up models. 10. Capital Asset Pricing Model (CAPM). 11. Proper Use of Beta. 12. Criticisms of CAPM and Beta versus Other Risk Measures. 13. Size Effect. 14. Criticisms of Size Effect. 14.1 Appendix. 15. D&P Risk Study. 16. Alternative models to the Build-Up and CAPM models Fama-French, APT, Market derived capital pricing model, Yield-Spread Model. 17. DCF Method. 18. Global Cost of Capital models. 19. Using Morningstar/Ibbotson Associates Cost of Capital Data. Part III. Corporate Financial Officers - Using Cost of Capital Data. 20. Capital Budgeting and Feasibility Studies. 21. Cost of capital for divisions/reporting units. 22. Cost of capital in valuing acquisition/merger. 23. Cost of capital in transfer pricing. 24. Cost of capital in Economic Value Added Financial Management System. Part IV. Cost of Capital for Closely-Held Entities. 25. Handling the Discount for Lack of Marketability For Operating Businesses. 26. The Private Company Discount. 27. Pass-through Entities: Partnerships LLCs and S corps. 27.1 Appendix. 28. Private Investment Companies. 29. Venture Capital Investments Part V. Other Topics. 30.

Shannon P. Pratt, CFA, FASA, MCBA, CM&AA, is the Chairman
and CEO of Shannon Pratt Valuations, Inc., and is the founder and
Editor Emeritus of Business Valuation Resources, LLC. He is the
author or coauthor of several industry standards, including Valuing
a Business: The Analysis and Appraisal of Closely Held Companies,
Valuing Small Businesses and Professional Practices, The Market
Approach to Valuing Businesses, Standards of Value, Business
Valuation and Taxes, The Lawyer's Business Valuation Handbook, and
Cost of Capital.

Roger J. Grabowski is managing director of Duff & Phelps
LLC. He has testified in court as an expert witness, including 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. Roger coauthors the annual Duff & Phelps's Risk
Premium Report. He is also the editor of Business Valuation
Review.

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