Best Practices in Estimating the Cost of Capital: An Update

2. Establish how the cost of equity is affected by capital structure decisions by defining financial risk and introducing the levered beta CAPM equation

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (Eds.). (2011). Essentials of corporate finance (7th ed., Rev.). New York, NY: McGraw-Hill Irwin.

Barb Williams and Rick Thomas, while attending an executive education course at a well-known business school, came across a case which involved calculating the cost of capital for Telus Corporation (Telus). Basic data such as the Balance Sheet, Income Statement, Data on Telus’ Common Stock, Market Index, and the Average Annual Returns in North American Capital Markets were provided. In order to calculate Telus’ cost of capital we need to calculate the company’s Cost of Equity, Cost of Debt, and Tax Rate along with their weighted cost and then apply these to the Weighted

We use Capital Asset Pricing Model (CAPM) approach to calculate the cost of equity. The formula of CAPM is re = rf + β × (E[RMkt] – rf).

Calculating a firm’s cost of capital has always been a key issue in financial management. To tackle this issue, WACC is one of the most widely used formulas even though the process is difficult, and results seem ambiguous. However, it is clear that WACC is the average cost of capital the firm must pay, in this case Home Depot (HD), to all its investors, both debt and equity holders. Since HD has debt to the tune of $29.6 billion (2012), it means that rwacc is an average of its debt and equity cost of capital. Based on the limiting factors revealed on the page 5, our confidence level in HD’s WACC is moderate. Nevertheless, since HD’s WACC is 5.97% it means that the company should only invest in projects

AGL Energy is an Australian company providing energy products and services. It is involved in the generation and retailing of electricity and is the “largest ASX listed owner, operator and developer of renewable energy generation in the country” (AGL Energy Ltd., 2016).

Two managers attending an executive education course attempt to develop a cost of capital estimate for a leading telecommunications company, Telus The two managers are somewhat confused about the costs of various sources of capital, the calculation of the overall cost of capital and the appropriate use of the hurdle rate

At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable

on Net Operating Profit after Taxes, the invested capital required to generate that income, and the WACC.

‘The Capital asset pricing model (CAPM) is a very useful model and it is used widely in the industry even though it is based on very strong assumptions. Discuss in the light of recent developments in the area.’

The course project involved developing a great depth of knowledge in analyzing capital structure, theories behind it, and its risks and issues. Before I began this assignment, I knew nothing but a few things about capital structure from previous unit weeks; however, it was not until this course’s final project that came along with opening

This case study focuses on where financial theory ends and practical application of the weighted average cost of capital (WACC) begins. It presents evidence on how some of the most financially complex companies and financial advisors estimated capital costs and focuses on the gaps found between theory and application. The approach taken in the paper differed from their predecessors in several various respects. Prior published information was solely based on written, closed-end surveys sent to a large number of firms, without a focused topic. The study set out to see if financial theory, specifically cost-of-capital, is truly ubiquitous in true business applications.

Already in 1958, Modigliani and Miller have pointed the discussion of capital structure towards the cost of debt and equity. According to their first proposition, in a world of no corporate taxes and with perfect markets, financial leverage has no effect on a firm’s value. In their second proposition, they state that the cost of equity equals a linear function defined by the required return on assets and the cost of debt (Modigliani and Miller, 1958).

L1 - Modigliani & Miller (1958) ‘The Cost of Capital, Corporation Finance and the Theory of Investment’

We use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. As