Best practice est wacc

This paper updates our earlier work on the state of the art in cost of capital estimation to identify current best practices that emerge. Unlike many broadly distributed multiple – A corporate survey participant converged into compelling recommendations about the cost of capital to a corporation. By the early 1990s, a consensus had emerged prompting descriptions such as “traditional… textbook… appropriate,” “theoretically correct,” “a useful rule of thumb” and a “good vehicle. ” In prior work with on conversations with practitioners at highly regarded on advice from best-selling textbooks and trade books.

Common theoretical frameworks to estimate the cost of variation, however, for the joint choices of the risk-free rate of return, beta and the equity market risk premium, as well of implementation. 1 study. We revisit the issues and see what now constitutes best practice and what has changed in both academic recommendations and in practice. practice has changed some since the late 1990s but there is still no consensus on important practical issues. The paper ends with a synthesis of messages from best practice capital costs. This evidence is valuable in several respects.

Application of cost of capital theory, setting the stage for productive debate and research on their resolution. Second, it helps interested companies to benchmark their cost of capital estimation practices against best-practice peers. Third, the evidence sheds light on the accuracy with which capital costs can be reasonably estimated, enabling executives to use the estimates more wisely in their decision-making. Fourth, it The authors thank Bob Bruner for collaboration on prior research. His duties as a dean, however, prevent his joining this effort. We thank MSCI for sharing Barra data.

The research would not have been possible without contributions notwithstanding, any errors remain the authors’. W. Todd Brotherson is Assistant professor at Southern Virginia University in Buena Vista, VA. Kenneth M. Eades is a Professor at the Darden Graduate School of Business Administration at the University of Virginia in Charlottesville, VA. Robert S. Harris is a Professor at the Darden Graduate School of Business Administration at the University of Virginia in Charlottesville, VA. Robert C. Higgins is Professor Emeritus at the Foster School of Business at the University of Washington in Seattle, WA.

1 To provide a self-contained article we draw directly on portions of our earlier work, Bruner, Eades, Harris, and Higgins (1998), which also discusses surveys from earlier years. 15 JOURNAL OF APPLIED FINANCE – NO. 1, 2013 16 do companies really estimate their cost of capital? ” The paper is part of a lengthy tradition of surveys of industry practice. For instance, Burns and Walker (2009) examine a large set of surveys conducted over the last A standard means of expressing a company’s cost of capital is the weighted-average of the cost of individual sources of capital employed.

In symbols, a company’s weighted-average cost of capital (or WACC) is: WACC = (Wdebt(1-t) Kdebt) + (WequityKequity), average cost of capital is the primary approach to selecting hurdle rates. More recently, Jacobs and Shivdasani (2012) implement cost of capital estimation. Our approach differs from most papers in several important respects. Typically studies are based on written, closed-end surveys sent wide array of topics, and commonly using multiple choice yields low response rates and provides limited opportunity to explore subtleties of the topic.

For instance, Jacobs and Shivdasani (2012) provide useful insights based on the Association for Finance Professionals (AFP) cost of capital survey. While the survey had 309 respondents, AFP (2011, page 18) reports this was a response rate of about 7% based on its membership companies. In contrast, we report the result of personal telephone interviews with practitioners from a carefully chosen group of leading corporations and theory is silent or ambiguous and practitioners are left to their own devices. The following section gives a brief overview of the weighted-average cost of capital.

The research approach and sample selection are discussed in Section II. Section III reports the general survey results. Key points of disparity are reviewed in Section IV. Section V discusses further survey results on risk adjustment to a baseline cost of capital, and Section VI highlights some institutional and market forces affecting cost of capital estimation. Section VII offers (1) where: K = component cost of capital. W = weight of each component as percent of total capital. t = marginal corporate tax rate. For simplicity, this formula includes only two sources of

capital; it can be easily expanded to include other sources as well. Finance theory offers several important observations when estimating a company’s WACC. First, the capital costs each form of capital. Second, the weights appearing in the based on often arbitrary, out-of-date book values. Third, the weighted-average expression to estimate a company’s cost of capital still confronts the practitioner with a number 2 As our survey results demonstrate, the most nettlesome component of WACC estimation is the cost forces practitioners to rely on more abstract and indirect II. Sample Selection

This paper describes the results of conversations with leading practitioners. Believing that the complexity of the I. The Weighted-Average Cost of Capital told in the practitioner’s own words. Though our telephone imposes an opportunity cost on investors; namely, funds are subtle differences in practice. Since our focus is on the gaps between theory and application rather than on average or typical practice, we market opportunities, corporate uses of capital must be benchmarked against these capital market alternatives. can earn in excess of its cost of capital on an average-risk