The Wacc User's Guide
24 Pages Posted: 11 Apr 2005
Abstract
The estimation of corporate capital costs is complicated by many practical issues that create numerous degrees of freedom and lead to wide-ranging results. We provide pragmatic solutions including:
* A global market risk premium (MRP) of about 5%, based on historical data, market expectations, and a review of the literature
* Several methods to derive reliable beta estimates including direct regressions, portfolio regressions, and constructed betas
* A normalized nominal riskless rate of about 5%, based on forward looking market data
* A value of tax shield framework that implies lower value and higher WACCs for more leveraged or volatile situations
* The WACC of a convertible bond, based on its economic decomposition of debt and equity
* A framework for global capital costs to supplement the risk analysis and qualitative considerations involved in global investing where risks are subject to rapid change . . . other international risks and costs should be incorporated into the cash flows and sensitivity analysis
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