Cost of Capital and Valuation
What return do the providers of capital expect in exchange for their investment? And how do we incorporate this return expectation on our journey to firm valuation? These are the two key questions we answer in this course.
The next logical step in our journey to firm valuation is to understand how to bring cash flows and discount rates together, that is, how to correcly identify the relvant risk-adjusted rate of return the investor require as a compensation for the riskiness of the expected cash-flow stream. We proceed as follows.
We start with some general thoughts about risk and how financial leverage affects the return of the shareholders.
Then we present the conceptual framework to estimate the present value of the firm's free cash flows. We introduce the two most prominent versions of the discounted cash flows (DCF) approach: The Adjusted Present Value (APV) approach and the Weighted Average Cost of Capital (WACC) approach.
We look in detail at how to estimate the WACC in reality.
We discuss important implementation issues when estimating the WACC in specific valuation situations.
We learn how to use international data to estimate the cost of capital.
For each topic, there is a short reading assignment, followed by some review questions and practice examples.