Shannon Pratt Business Valuations - Cost of Capital, Applications and Examples, Third Edition

Cost of Capital, Applications and Examples, Third Edition

By Shannon P. Pratt and Roger J. Grabowski

The new edition of Cost of Capital: Applications and Examples Third Edition includes new materials on using the Duff & Phelps Risk Premium Report data on size and fundamental risk, new chapters on cost of capital issues for financial reporting and transfer pricing, updated discussion of Cost of Capital in the Courts with comprehensive set of case references, and Reconciling Cost of Capital among various forms of the Income Approach and expanded material reconciling the Income Approach with Valuation Multiples in the Market Approach. Throughout, there are new quotes and citation to relevant material.
800 pages

Contents

About the Authors xi
Foreword xvii
Preface xix
Acknowledgments xxiii
Introduction xxv
Notation System and Abbreviations Used in This Book xxix
Cost of Capital Basics 1
Defining Cost of Capital 3
Introduction to Cost of Capital Applications: Valuation and Project Selection 9
Net Cash Flow: Preferred Measure of Economic Income 15
Discounting versus Capitalizing 23
Relationship between Risk and the Cost of Capital 39
FASB's Concepts Statement No. 7: Cash Flows and Present Value Discount Rates 48
Cost Components of a Company's Capital Structure 51
Estimating the Cost of Equity Capital and the Overall Cost of Capital 67
Build-up Method 69
Capital Asset Pricing Model 79
Equity Risk Premium 89
Bias Issues in Compounding and Discounting 114
Beta: Differing Definitions and Estimates 117
Formulas and Examples for Unlevering and Levering Equity Betas 143
Examples of Computing OLS Beta, Sum Beta, and Full-Information Beta Estimates 151
Criticism of CAPM and Beta versus Other Risk Measures 161
Example of Computing Downside Beta Estimates 176
Size Effect 179
Criticisms of the Size Effect 209
Other Data Issues Regarding the Size Effect 220
Company-Specific Risk 225
Alternative Cost of Equity Capital Models 243
Implied Cost of Equity Capital 255
Weighted Average Cost of Capital 265
Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital When Capital Structure Is Constant 283
Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital When Capital Structure Is Changing 297
Global Cost of Capital Models 309
Using Morningstar Cost of Capital Data 331
Corporate Finance Officers: Using Cost of Capital Data 361
Capital Budgeting and Feasibility Studies 363
Cost of Capital for Divisions and Reporting Units 369
Cost of Capital in Evaluating Acquisitions and Mergers 385
Cost of Capital in Transfer Pricing 393
Central Role of Cost of Capital in Economic Value Added 409
Cost of Capital for Closely Held Entities 417
Handling the Discount for Lack of Marketability for Operating Businesses 419
Private Company Discount 429
Cost of Capital of Interests in Pass-Through Entities 437
Cost of Capital in Private Investment Companies 449
Relationship between Risk and Returns in Venture Capital Investments 469
Other Topics 479
Minority versus Control Implications of Cost of Capital Data 481
How Cost of Capital Relates to the Excess Earnings Method of Valuation 493
Adjusting the Discount Rate to Alternative Economic Measures 501
Estimating Net Cash Flows 505
Estimating the Value of a Firm in Financial Distress 518
Common Errors in Estimation and Use of Cost of Capital 529
Cost of Capital in the Courts 539
Real Estate and Ad Valorem 559
Cost of Capital of Real Property-Individual Assets 561
Valuing Real Property 580
Cost of Capital of Real Estate Entities 587
Valuing Real Estate Entities 615
Cost of Capital in Ad Valorem Taxation 623
Advice to Practitioners 639
Dealing with Cost of Capital Issues 641
Questions to Ask Business Valuation Experts 647
Appendices 653
Bibliography 655
Data Resources 683
International Glossary of Business Valuation Terms 693
Sample Report Submitted to U.S. Tax Court Roger J. Grabowski 703
ValuSource Valuation Software 725
Review of Statistical Analysis 733
Index 771