Cost of capital applications and examples pdf
Does the Capital Asset Pricing Model Work?A company is raising funds from different sources of finance and doing business with those funds. The company has a responsibility to give a return to its funding providers. If a company has only one source of financing, then it is the rate at which it is required to earn from the business. However, the company may have raised funds from more than one source of finance, in which case WACC Weighted Average Cost of Capital must be found, which indicates the minimum rate at which the company should earn from the business in order to give a return to its finance providers, as per their expectations. The calculation of important metrics like net present values and economic value added requires the WACC. It is equally important for investors making valuations of companies.
Weighted Average cost of Capital (WACC) under Book Value Approach ~ Financial Management
But estimating the cost of equity causes a lot of head scratching; often the result is subjective and therefore open to question as a reliable benchmark. This article describes a method for arriving at that figure, a method […]. This article describes a method for arriving at that figure, a method spawned in the rarefied atmosphere of financial theory.
Importance and Use of Weighted Average Cost of Capital (WACC)
Definition : As it is evident from the name, cost of capital refers to the weighted average cost of various capital components , i. In finer terms, it is the rate of return , that must be received by the firm on its investment projects, to attract investors for investing capital in the firm and to maintain its market value. On raising funds from the market, from various sources, the firm has to pay some additional amount, apart from the principal itself. The additional amount is nothing but the cost of using the capital, i. To cover the cost of raising funds from the market, cost of capital must be obtained.
The Association for Financial Professionals surveyed its members about the assumptions built into the financial models they use to evaluate investment opportunities. Remarkably, no survey question received the same answer from a majority of the more than respondents. With trillions of dollars in cash sitting on their balance sheets, corporations have never had so much money. Although investment opportunities vary dramatically across companies and industries, one would expect the process of evaluating financial returns on investments to be fairly uniform. After all, business schools teach more or less the same evaluation techniques. Such analyses rely on free-cash-flow projections to estimate the value of an investment to a firm, discounted by the cost of capital defined as the weighted average of the costs of debt and equity.
COST OF CAPITAL Applications and Examples Third Edition SHANNON P. PRATT ROGER J. GRABOWSKIJohn Wiley & Sons, Inc. C.
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