Best Practices in Estimating the Cost of Capital
Best Practices in Estimating the Cost of
Capital: Survey and Synthesis
Robert F. Bruner, Kenneth M. Eades, Robert S. Harris, and Robert C. Higgins
This paper pn ^ents ihns, Wn
Itujjlini; finunaal advtsi-i's. lUic -M-ven, best selling texlho(>k.\ and trade hooks. The re.sulls show close aligninvn! ainuu-^:, all lh< M S, y'i'jps an ihc use of common theoreliva! frameworks and on many aspects of estimation. We Jin a ''an.>( •arunhtn. however, for the joint choices oflhe nsk-free rate. heia. and the equity market risk pn/nviun xs wi'U asforthe adjustment of capital costs for specific investment risk.
On these issuer, we ••.innmarr-f rj'^iimcnts for different approaches and review responses in detail to glean tradeoffs .dh^ pruct^n^^uers.. (.lEL: GI2, G2(K GM j
• In recent decades, llieorelical breakthroughs in sueh areas as portfolio divcrsificatKHi. r ^aikei efficiency, and
^
asset prieing have conxcrgrd iiHO compelling recommendations abitut ihe ct iM of capita! to a corporation. By the carlv \9^)ih,. .1 cf^uiHcnsus had emerged prompting such ticscripiions as
"traditional..,text book,,,appropri -Ik:,*' ''iheorelically correct," and "a usefy] rule of Itiiiinb and a good vehicle."' Beneath this general ag reiiiieet about costof-capital theory lies con^iclera bk' atrtblguity and confusion over how ihe iticor} t an best be applied.
The issues at stake are sufficie;ni]y important that differing choices on a few key c Icinents can iead to wide disparities in csiimLiicd capi rai cosi. The c(»st of capital is cenii-al lo oiDdcrn fiiijiK'C iouching on investment and divesEineni deci sion-, measures of economic profit, performance app rjisai. and incentive systems. Fach year in ihc l^S. cor poiatmns undertake more than S500 billion in capiia '• spending- Since a
Robert F, Bruner. Kensicih M l',ul koheri S. Harris are
P r o f e s s o r s a I t h e Dar(K-n (fKiduiHC ~5, hsiol nj" B u s i n e s s
A d m i n i s t r a t i o n . Lini\'Cis,i) oi'
Capital: Survey and Synthesis
Robert F. Bruner, Kenneth M. Eades, Robert S. Harris, and Robert C. Higgins
This paper pn ^ents ihns, Wn
Itujjlini; finunaal advtsi-i's. lUic -M-ven, best selling texlho(>k.\ and trade hooks. The re.sulls show close aligninvn! ainuu-^:, all lh< M S, y'i'jps an ihc use of common theoreliva! frameworks and on many aspects of estimation. We Jin a ''an.>( •arunhtn. however, for the joint choices oflhe nsk-free rate. heia. and the equity market risk pn/nviun xs wi'U asforthe adjustment of capital costs for specific investment risk.
On these issuer, we ••.innmarr-f rj'^iimcnts for different approaches and review responses in detail to glean tradeoffs .dh^ pruct^n^^uers.. (.lEL: GI2, G2(K GM j
• In recent decades, llieorelical breakthroughs in sueh areas as portfolio divcrsificatKHi. r ^aikei efficiency, and
^
asset prieing have conxcrgrd iiHO compelling recommendations abitut ihe ct iM of capita! to a corporation. By the carlv \9^)ih,. .1 cf^uiHcnsus had emerged prompting such ticscripiions as
"traditional..,text book,,,appropri -Ik:,*' ''iheorelically correct," and "a usefy] rule of Itiiiinb and a good vehicle."' Beneath this general ag reiiiieet about costof-capital theory lies con^iclera bk' atrtblguity and confusion over how ihe iticor} t an best be applied.
The issues at stake are sufficie;ni]y important that differing choices on a few key c Icinents can iead to wide disparities in csiimLiicd capi rai cosi. The c(»st of capital is cenii-al lo oiDdcrn fiiijiK'C iouching on investment and divesEineni deci sion-, measures of economic profit, performance app rjisai. and incentive systems. Fach year in ihc l^S. cor poiatmns undertake more than S500 billion in capiia '• spending- Since a
Robert F, Bruner. Kensicih M l',ul koheri S. Harris are
P r o f e s s o r s a I t h e Dar(K-n (fKiduiHC ~5, hsiol nj" B u s i n e s s
A d m i n i s t r a t i o n . Lini\'Cis,i) oi'