Cost of Capital: Applications and Examples

Cost of capital estimation has long been recognized as one of the most critical elements in business valuation, capital budgeting, feasibility studies, and corporate finance decisions. It is also the most difficult procedure to perform and assess. In this long-awaited Third Edition of Cost of Capital: Applications and Examples, renowned valuation experts and authors Shannon Pratt and Roger Grabowski address the most controversial issues and problems in estimating the cost of capital.

Presenting both the theoretical development of cost of capital estimation and its practical application to valuation, capital budgeting, forecasting of expected investment returns, and rate-setting problems encountered in current practice, Cost of Capital is both a learning text and a handy reference for both the practitioner and the reviewer. Pratt and Grabowski deftly review and explore the theory of what drives the cost of capital, the models currently in use to estimate cost of capital, and the data available as inputs to the models to estimate cost of capital.

Now in a thoroughly updated and comprehensive Third Edition, Cost of Capital summarizes the results and practical implications of the latest research—much of which is gleaned from never-before-published academic working papers—and includes scores of formulas and elucidating examples throughout to enhance readers' insights. Pratt and Grabowski have updated their text to include a host of new material, including:

• A new chapter covering cost of capital for financial reporting under SFAS 141, 142 and 144
• A new chapter on risk measures and their relationship to cost of capital
• Extensive examples illustrating development of cost of equity by the build-up method and the capital asset pricing model using size premiums from Morningstar and the authoritative Duff & Phelps's Risk Premium Report data; development of company-specific risk premiums using Duff & Phelps's Risk Premium Report risk/return data; and development of capital structure at market value and weighted average cost of capital with constant and varying capital structures
• A new chapter covering cost of capital for companies in developing economies
• A new chapter covering cost of capital for transfer pricing
• An update of "Cost of Capital in the Courts"
• Handling the Discount for Marketability" chapter is now expanded to include sources of data on minority interest transactions and control transactions
• Specialized chapters by leading experts in real estate, property tax, and family limited partnership valuations

In addition to detailed exposition of the build-up and capital asset pricing models for estimating the cost of capital, Pratt and Grabowski present in-depth analysis of the components, including the equity risk premium, beta and the size effect. The dynamic author team also analyzes criticism of major models for developing estimates of the cost of capital in use today and also present procedures for a number of alternative models. This definitive text is an indispensable reference tool for professional valuation practitioners as well as attorneys and judges, investment bankers, CFOs, academicians and students, and CPAs.