The Cost of Capital: Intermediate TheoryThis book provides an answer to the question, 'What does the finance and economics literature say about the determination and estimation of a project's cost of capital?'. Uniquely, it reviews both the theory of asset pricing in discrete time and a range of more applied topics which relate to project valuation, including the effects of corporate and personal taxes, the international dimension, estimation of the cost of equity in practice, and the cost of capital for regulated utilities. It seeks to explain models and arguments in a way which does justice to the reasoning, whilst minimising the prior knowledge of finance and maths expected of the reader. It acts as a bridge between a general undergraduate or MBA text in finance, accounting or economics, and the modern theoretical literature on the cost of capital. |
Contents
The cost of capital under certainty | 3 |
contingent states | 20 |
The capital asset pricing model and multifactor models | 38 |
The consumptionbased model | 68 |
The equity risk premium | 87 |
Project valuation | 123 |
Corporation tax leverage and the weighted average cost of capital | 153 |
the old and the new views | 181 |
Inflation and risk premiums | 225 |
The international dimension | 236 |
inference from present value | 261 |
applying the CAPM and multifactor models | 278 |
Estimating a projects cost of capital | 300 |
Regulated utilities | 323 |
| 335 | |
| 347 | |
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Common terms and phrases
adjustment advantage to debt arbitrage arithmetic mean asset pricing assumed assumption beta bonds book value C₁ cent p.a. company's constant corporation tax cost of capital cost of debt cost of equity covariance discount factor discount rate dividend discount model effect efficient portfolio elementary claims equation equilibrium equity and debt equity premium example excess return expected cash flows expected rate expected return expected utility expected value financial assets firm forecast given implies income increase inflation interest rate investment investors leverage marginal utility market portfolio market value maximise measured method multifactor models negative nominal pay-off period personal tax predicted present value project's cost rate of return real rate real return return on equity risk aversion risk premium risk-free rate risky assets shareholders standard CAPM T₁ tax advantage tax rate tax savings tax-adjusted WACC trading United unlevered utility function valuation variables variance WACC zero