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Cost of Capital: Workbook and Technical Supplement, 4th Edition

ISBN: 978-0-470-94492-9
255 pages
October 2010
Cost of Capital: Workbook and Technical Supplement, 4th Edition (0470944927) cover image
Praise for Fourth Edition of Cost of Capital Workbook and Technical Supplement

"Pratt and Grabowski went the extra mile to supplement their magnum opus by providing this Workbook and Technical Supplement. As a finance professor for many years, I know from experience that students and teachers really value supplements to textbooks. It allows the teacher to help the student to review and apply what was presented in the text, and the PowerPoints are a great service to teachers in course preparation. The website provides various worksheets that show the inner workings of the models. I enthusiastically recommend the Workbook and Technical Supplement to finance professors and teachers and their students.
Daniel L. McConaughy, PhD, ASA, Professor of Finance, California State University, Northridge, Valuation Services, Crowe Horwath LLP

"The Workbook and Technical Supplement provides a detailed tutorial on understanding and executing the theoretical concepts explained in the Fourth Edition. This supplement is three books in one. Part One is a step-by-step tutorial on estimating certain key components of the cost of equity capital. Part Two provides a bridge between the theory and some practical applications, such as estimating the cost of capital for real property. Parts Three and Four allow the readers to test their comprehension of the concepts and identify areas for a review. It is almost as good as having Professors Pratt and Grabowski looking over your shoulder to ensure that one is both comprehending and correctly implementing the complex concepts.."
Ashok Abbott, PhD, Associate Professor of Finance, College of Business & Economics, West Virginia University

"This text provides the most comprehensive coverage of cost of capital issues that I have seen to date. Messrs. Pratt and Grabowski have created a very accessible and lucid treatment of what most would consider an opaque subject. The Fourth Edition is especially important for its new topics as well as expanded coverage of concepts from earlier editions. Of particular interest is the review of the extreme market conditions during the 2008–2009 crisis and the effect that the unprecedented volatility had on traditional cost of capital models. For years, Pratt and Grabowski's research has informed the business valuation curriculum of the American Society of Appraisers. This book will be added to our reading list, and thousands of students worldwide will benefit from the state?of?the?art content of the Fourth Edition and the companion Workbook and Technical Supplement. Furthermore, Cost of Capital, Fourth Edition should be a mandatory part of every valuation practitioner's library. If you buy this book, you can expect it to become well worn and remain on your desk within arm's length until the publication of the Fifth Edition."
John Barton, ASA, CPA, Chairman, Business Valuation Committee, ASA

"Cost of capital is so much more complex than it used to be. With so many additional considerations regarding each variable of the cost of capital formula, this book is a must for anyone that needs to understand or develop a discount rate. Even the most experienced practitioner will benefit from the outstanding work of Pratt and Grabowski. This book has to become part of your library."
Gary R. Trugman, CPA/ABV, MCBA, ASA, MVS, President, Trugman Valuation Associates, Inc.

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Preface.

About the Author.

Acknowledgments.

Notation System and Abbreviations Using in This Book.

PART ONE: Technical Supplement—Supplements to Chapters of Cost of Capital: Applications and Examples, 4th ed.

CHAPTER 1: Alternative Net Cash Flow Definitions—Supplement to Chapter 3.

Introduction.

Equity Cash Flow Method.

Invested Capital Method.

Capital Cash Flow Method.

Adjusted Present Value Method.

Residual Income Method.

CHAPTER 2: Examples of Computing OLS Beta, Sum Beta, and Full Information Beta Estimates—Supplement to Chapter 10.

Introduction.

Computing OLS and Sum Beta Estimates—An Example.

Computing Full-Information Beta Estimate—An Example.

CHAPTER 3: Estimating Beta: Interpreting Regression Statistics—Supplement to Chapter 10.

Introduction.

Evaluating Beta Estimation Output.

Evaluating Regression Output.

CHAPTER 4: Example of Computing Downside Beta Estimates—Supplement to Chapter 12.

Introduction.

Computing Downside Beta Estimates.

CHAPTER 5: Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital When Capital Structure Is Constant—Supplement to Chapter 18.

Introduction.

Capital Asset Pricing Model and Beta.

Solution: The Iterative Process.

Iterative Process Using a Financial Spreadsheet Model.

Summary.

Additional Reading.

CHAPTER 6: Iterative Process Using CAPM to Calculate the Cost of Equity Component of the Weighted Average Cost of Capital When Capital Structure Is Changing—Supplement to Chapter 18.

Introduction.

Assumptions Inherent in Weighted Average Cost of Capital.

Solution: Iterative Process with Changing Capital Structure.

Iterative Process Using Financial SpreadsheetModel.

Equity Value.

Summary.

Additional Reading.

CHAPTER 7: Cost of Capital and the Valuation of Worthless Stock—Supplement to Chapter 16.

Introduction.

Liquidating Value.

Potential Value.

Example.

Possibility That Value of the Business Enterprise Exceeds the Face Value of Debt—Pricing Equity as a Call Option.

Potential Future Value: Probability That Business Enterprise Exceeds Face Value of Debt.

Additional Considerations.

Summary.

PART TWO: Technical Supplement—Specific Applications of Cost of Capital.

CHAPTER 8: Cost of Capital of Private Investment Company Interests.

Introduction.

The Private Investment Company.

Relationships between Time to a Liquidity Event and Value.

Lack of Control.

Lack of Marketability or Illiquidity.

Example Valuation of PIC Interest.

Summary.

CHAPTER 9: Cost of Capital of Real Property—Individual Assets.

Introduction.

Typical Structure of a Real Estate Transaction.

Real Property Competes with Other Asset Classes.

Direct Capitalization Method.

Discounted Cash Flow Method.

Estimating the Property Discount Rate.

Summary.

Appendix 9A: Valuing Real Property.

CHAPTER 10: Cost of Capital of Real Estate Entities.

Introduction.

Definition of a Real Estate Entity.

Measuring Net Cash Flow for Real Estate Entities.

Valuation of Real Estate Entities.

Summary.

Additional Reading.

Appendix 10A: Valuing Real Estate Entities.

PART THREE: Learning Objectives, Questions, and Problems.

PART FOUR: Answers and Solutions.

Index.

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Shannon P. Pratt, CFA, ARM, ABAR, FASA, MCBA, CM&AA, referred to as the father of business valuations, is the author of several bestselling Wiley business valuation books and a sought-after speaker at business valuation industry conferences. He is the managing owner of Shannon Pratt Valuations Portland, Oregon, and has served as supervisory analyst for over 3,000 business valuation engagements in forty years and as an expert witness in numerous state and federal courts on contested business valuations.

Roger J. Grabowski is managing director of Duff & Phelps LLC. Roger has testified in court as an expert witness on the value of closely held businesses and business interests, matters of solvency, valuation, and amortization of intangible assets, and other valuation issues. He testified in 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. Grabowski authors the annual Duff & Phelps Risk Premium Report.

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