2017 Valuation Handbook - U.S. Guide to Cost of Capital

by Unknown

• ISBN13: 9781119367123
• ISBN10: 1119367123
• Edition: 1st
• Format: Hardcover
• Copyright: 2017-04-10
• Publisher: Wiley

Summary

Ensure that you're using the most up-to-date data available: Buy the 2017 Valuation Handbook – U.S. Guide to Cost of Capital + Quarterly PDF Updates together!

The New Industry Standard in Business Valuation Reference Materials

2017 Valuation Handbook – U.S. Guide to Cost of Capital provides the key annual valuation data previously published in (i) the now discontinued Morningstar/Ibbotson SBBI Valuation Yearbook (discontinued in 2013), and (ii) the Duff & Phelps Risk Premium Report Study (no longer published as a stand-alone publication).

The size premia data previously published in the SBBI Valuation Yearbook is referred to as the "CRSP Deciles Size Premia" exhibits in the new 2017 Valuation Handbook – U.S. Guide to Cost of Capital, while the size and risk premia data published in the Duff & Phelps Risk Premium Report Study has been published annually since 1996 and, like the former SBBI Valuation Yearbook, provides data and methodology that can be used to develop cost of equity capital estimates using (i) the build-up method and (ii) the capital asset pricing model (CAPM).

The 2017 Valuation Handbook – U.S. Guide to Cost of Capital includes data through December 31, 2016, and is intended to be used for 2017 valuation dates.

For more information about Duff & Phelps valuation data resources published by Wiley, please visit www.wiley.com/go/valuationhandbooks.

Also Available

• 2017 Valuation Handbook – U.S. Industry Cost of Capital
• 2017 Valuation Handbook – International Guide to Cost of Capital
• 2017 Valuation Handbook – International Industry Cost of Capital

Key Features

• Key cost of capital inputs: The 2017 Valuation Handbook – U.S. Guide to Cost of Capital provides the key inputs needed for developing the cost of equity capital (i.e., "discount rate") for use in estimating the value of a subject business, business ownership interest, security, or intangible asset. Inputs provided include: equity risk premia, size premia, risk premia over the risk free rate, full-information industry betas, industry risk premia, and the risk-free rate.
• Discussion of topics that come up most when performing valuation analysis: The 2017 Valuation Handbook – U.S. Guide to Cost of Capital includes straightforward discussions about: (i) valuation theory, (ii) the differences between the various cost of capital estimation models (build-up, CAPM, Fama-French), (iii) understanding the basic building blocks of cost of equity capital (the risk-free rate, the equity risk premium, the size premium, beta, the industry risk premium, the company-specific risk premium), (iv) whether to "normalize" risk-free rates or not, (v) a detailed comparison of the CRSP Deciles Size Premia Study (the former SBBI Valuation Yearbook data) and the Risk Premium Report Study, and more.
• Easy-to-follow examples: The 2017 Valuation Handbook – U.S. Guide to Cost of Capital is packed with easy-to-understand examples for properly using the data to develop levered, unlevered, and even "high-financial-risk" cost of equity capital estimates using various build-up methods and CAPM.

Author Biography

Roger J. Grabowski is a managing director with Duff & Phelps. He is coauthor of Cost of Capital – Applications and Examples, Fifth Edition, The Lawyer's Guide to Cost of Capital, and Cost of Capital in Litigation.

James P. Harrington is a director at Duff & Phelps. He is a leading contributor to Duff & Phelps' efforts in the development of studies, surveys, online content and tools, firm-wide valuation models, data distribution platforms, and published thought leadership. He is a coauthor of the Duff & Phelps "Valuation Handbook" series, a contributing author to Cost of Capital – Applications and Examples, Fifth Edition, and a Duff & Phelps contributor to the Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook.

Carla S. Nunes is a managing director in the Office of Professional Practice at Duff & Phelps, where she provides firm-wide technical guidance on a variety of valuation, financial reporting, and tax issues, with a particular focus on cost of capital. She is a coauthor of the Duff & Phelps "Valuation Handbook" series and a contributing author to Cost of Capital – Applications and Examples, Fifth Edition.

Table of Contents

Acknowledgements xiv

Introduction xv

Chapter 1 Cost of Capital Defined 1-1

Introduction 1-1

Income Approach Overview 1-2

Discounting versus Capitalizing Concepts 1-2

Valuation Date 1-5

Basic Cost of Capital Concepts 1-5

Sources of Capital 1-9

Cost of Capital Input Assumptions 1-10

Capital Structure Considerations 1-16

Calculating WACC 1-18

Estimates of Cost of Capital are Imprecise 1-19

Key Things to Remember about Cost of Capital 1-21

Chapter 2 Methods for Estimating the Cost of Equity Capital 2-1

Basic Framework 2-1

Types of Risk 2-6

Cost of Equity Capital Estimation Methods 2-8

Build-up 2-10

CAPM 2-11

Other Cost of Equity Capital Estimation Methods 2-15

Key Things to Remember about the Methods for Estimating the Cost of Equity Capital 2-17

Chapter 3 Basic Building Blocks of the Cost of Equity Capital– Risk-free Rate and Equity Risk Premium 3-1

The Risk-free Rate and Equity Risk Premium: Interrelated Concepts 3-1

Spot Risk-free Rates versus Normalized Risk-free Rates 3-2

Global Turbulence and Impact on Interest Rates 3-14

Methods of Risk-free Rate Normalization 3-19

Spot Yield or Normalized Yield? 3-23

Concluded Normalized Risk-free Rate 3-25

Equity Risk Premium 3-26

Estimating the Equity Risk Premium 3-27

Duff & Phelps Recommended U.S. ERP 3-38

Economic and Financial Market Indicators 3-39

Quantitative Models 3-44

Concluding on an ERP 3-48

Chapter 4 Basic Building Blocks of the Cost of Equity Capital – Size Premium 4-1

Size as a Predictor of Equity Returns 4-1

Possible Explanations for the Greater Returns of Smaller Companies 4-2

The Size Effect: Empirical Evidence 4-2

The Size Effect Over Longer Periods 4-3

The Size Effect Tends to Stabilize Over Time 4-6

The Size Effect Changes Over Time 4-7

Criticisms of the Size Effect 4-8

Data Issues 4-12

Has the Size Effect Disappeared in More Recent Periods? 4-17

Relationship of Size and Liquidity 4-21

Key Things to Remember about the Size Premium 4-26

Chapter 5 Basic Building Blocks of the Cost of Equity Capital – Betas and Industry Risk Premia 5-1

Beta 5-1

Differences in Estimation of Equity Betas 5-7

Full-Information Beta 5-11

Industry Risk Premia 5-12

Full-Information Beta Methodology 5-16

Debt Betas 5-17

Unlevering and Levering Equity Betas 5-18

Key Things to Remember about Betas and the Industry Risk Premia 5-19

Chapter 6 Basic Building Blocks of the Cost of Equity Capital – Company-specific Risk Premia 6-1

Introduction 6-1

Adjustments for Differences in Risk 6-2

Adjustments for Risk in Net Cash Flows and Biased Projections 6-5

Adjustments for Other Risk Factors 6-7

Matching Fundamental Risk and Return 6-8

Key Things to Remember about Company-specific Risk Premia 6-10

Chapter 7 The CRSP Deciles Size Premia Studies and the Risk Premium Report Studies– A Comparison 7-1

History of the CRSP Deciles Size Premia Studies 7-1

History of the Risk Premium Report Studies 7-2

Data Sources 7-2

Definitions of “Size” 7-6

Time Period Examined 7-7

Number of Portfolios 7-7

Portfolio Overlap 7-7

Guideline Portfolio Method and Regression Equation Method 7-8

Risk Premia Over CAPM (Size Premia) 7-8

“Smoothed” Premia versus “Average” Premia 7-12

OLS Beta versus Sum Beta 7-12

Risk Premia Over the Risk Free Rate 7-12

Unlevered Premia 7-13

Risk Study 7-13

Characteristics of Companies in Portfolios 7-13

Online Applications 7-14

Chapter 8 CRSP Deciles Size Premia Examples 8-1

Build-up Example 8-1

CAPM Example 8-4

Key Things to Remember about the CRSP Deciles Size Premia 8-7

Chapter 9 Risk Premium Report Exhibits – General Information 9-1

Appropriate Use of the Risk Premium Report Exhibits 9-1

How the Risk Premium Report Exhibits are Organized 9-2

Cost of Equity Capital Estimation Methods Available 9-3

Proper Application of the Equity Risk Premium (ERP) Adjustment 9-4

“Smoothed” Premia versus “Average” Premia 9-7

The “Guideline Portfolio Method” versus the “Regression Equation Method” 9-8

Example: Calculating an Interpolated Premium Using the Regression Equation Method 9-9

Tips Regarding the Regression Equation Method 9-10

Can the Regression Equation Method be Used If the Subject Company Is Small? 9-10

Size Study or Risk Study? 9-11

Key Things to Remember About the Risk Premium Report Exhibits 9-12

Chapter 10 Risk Premium Report Exhibits – Examples 10-1

Size Study 10-1

Reasons for Using Additional Measures of Size 10-1

The Difference Between the Size Study’s A Exhibits and the B Exhibits 10-2

The Difference Between “Risk Premia Over the Risk-free Rate” and “Risk Premia Over CAPM” 10-2

Calculating Custom Interpolated Premia for Smaller Companies 10-6

Overview of Methods Used to Estimate Cost of Equity Capital Using the Size Study 10-9

Size Study Examples: Assumptions Used 10-10

Size Study Examples 10-12

Unlevered Cost of Equity Capital 10-17

Overview of the Methodology and Assumptions Used to Unlever Risk Premia 10-18

Estimating Cost of Equity Capital Using the “Build-up 1-Unlevered” Method 10-22

Estimating Cost of Equity Capital Using the Capital Asset Pricing Model (CAPM) 10-26

Estimating Cost of Equity Capital Using the “Build-up 2” Method 10-30

Risk Study 10-35

Overview of Methods Used to Estimate Cost of Equity Capital Using the Risk Study 10-42

Risk Study Examples 10-45

Build-up 3-Unlevered 10-49

High-Financial-Risk Study 10-51

Overview of Methods Used to Estimate Cost of Equity Capital Using the High-Financial-Risk Study 10-57

Estimating Cost of Equity Capital Using the “Build-up 1-High-Financial-Risk” Method 10-58

Estimating Cost of Equity Capital Using the “CAPM-High-Financial-Risk” Method 10-61

Comparative Risk Study 10-63

Using the Comparative Risk Study to Refine Build-up Method Estimates 10-67

Using the Comparative Risk Study to Refine CAPM Estimates 10-69

Chapter 11 Real Estate 11-1

Individual Real Estate Assets 11-1

Real Estate Investment Trusts (REITs) 11-2

Structure of Real Estate Entities 11-3

Correlation of U.S. REITs Compared to Other U.S. Asset Classes 11-4

Summary Statistics of U.S. REITs Compared to Other U.S. Asset Classes 11-6

Real Estate Property Valuation Inputs 11-8

Key Things to Remember about Real Property Valuation 11-17

Chapter 12 Answers to Commonly Asked Questions 12-1

Glossary

Index

Appendix 1 – Definitions of Standard & Poor’s Compustat Data Items Used to Calculate the Risk Premium Report Exhibits

Appendix 2 – Changes to the Risk Premium Report Over Time

Appendix 3 – CRSP Deciles Size Premia Study: Key Variables

Appendix 3a – Industry Risk Premium (RPi)

Appendix 3b – Debt Betas

Appendix 4 – Risk Premium Report Study Exhibits