7/31/2019 2010 NovDec Dorrell Review

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November/December 2010 The Value Examiner4

A P R O F E S S I O N A L D E V E L O P M E N T J O U R N A L f o r t h e C O N S U L T I N G D I S C I P L I N E S

a superb staff training resource that willbe a signicant time saver for your rm.

Your technical library will not becomplete without this comprehensivereference. You need not rely upon my recommendation alone. Te foreword

is written by Stephen P. Lamb, Esq.,who carries substantial authority re-garding the books focus. Stephen isa partner with Paul, Weiss, Rifkind,Wharton & Garrison in their Wilming-ton, DE, offi ce. Signicantly, he is a for-mer vice chancellor, Delaware Court of Chancerya venue widely regarded forits scrutiny of the discounted cash ow method, which is singularly dependenton the cost of capital.

Te preface establishes the corner-stone of the text: Cost of capital is argu-ably the most important concept in all of nance.

Te preface explains the dramaticchanges to the cost of capital result-ing from the nancial crisis beginningin 2008, and the subsequent recession.Te conditions adversely affected tra-

ditional methods of cost of capital de-termination precisely at a time whenthe factor was most needed.

Te preface lists the texts objectiveas serving two primary user categories:

he practitioner who seeks a

greater understanding of the lat-est theory and practice in cost of capital estimation

Te reviewer who needs to make aninformed evaluation of another par-tys methodology and data used toproduce a cost of capital estimate

Following are are highlights fromthe table of contents:

Part 1Cost of Capital Basics (6chapters, 77 pages). Te basics coverdenitions, applications, net cash ow,discounting versus capitalizing, therelationship between risk and cost of capital, and the cost components of abusinesss capital structure.

Part 2Estimating the Cost of Equity Capital and the Overall Cost of Capital (14 chapters, 371 pages). Alonwith a new chapter on distressed busi-nesses, this covers the build-up meth-od, CAPM and criticisms, ERP, Betadistinctions and criticisms, size effecand criticisms, company-specic riskalternative models (e.g., AP , WACC)global cost of capital models, and using Morningstar data. Also, many ofthe topics have supporting appendices,

which amplify the text admirably.

Part 3Corporate Finance Offi -cers: Using Cost of Capital (6 chapter100 pages). Tis part focuses on valuationconcepts used in day-to-day businessdecision making. Tey cover budgetingand feasibility studies, cost of capital fodivisions and reporting units, evaluatingacquisitions and mergers, transfer pric-ing and EVA (economic value added)Tis edition includes an added chapteron using cost of capital for fair value re-porting of intangible assets.

Part 4Other Cost of CapitalConsiderations (8 chapters, 112 pages). opics include DLOM for operat-ing businesses, PCD (private companydiscount), pass-through entity and

The rst edition of Cost of Capital was published in 1998. Te second edi-tion was published in 2002, and the third edition in 2008. Dont presumethat the fourth edition could not add knowledge to the topicit is repletewith incremental content that rounds out the three previous editions.

And, the 2010 Workbook and Technical Supplement , which I read as well, provides

By Shannon P. Pratt and Roger J. Grabowski Wiley & Sons, New Jersey, October 2010 (754 pages, hardcover, $160)

Reviewed by Darrell D. Dorrell, MBA, CPA/ABV, CVA, ASA, CMA, DABFA, CMCA

Cost of Capital: Applicationand Examples, Fourth Editio

B O O K R E V I E W

7/31/2019 2010 NovDec Dorrell Review

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November/December 2010The Value Examiner

A P R O F E S S I O N A L D E V E L O P M E N T J O U R N A L f o r t h e C O N S U L T I N G D I S C I P L I N E S

private investment company discountrates, venture capital investments, mi-nority versus control implications, rela-tionship to excess earnings method of valuation, adjusting the discount rateto alternative economic measures, andestimating net cash ows.

Part 5Advice to Practitioners (2 chapters, 31 pages). Tis part coverscommon errors in the estimation anduse of cost of capital, as well as advicefrom the authors about dealing withspecic, often controversial, cost of capital issues.

Workbook (10 chapters organizedinto four parts, not including appendi-ces; approximately 250 pages).

Besides Pratt and Grabowski, 15other nationally recognized authorsmade substantial contributions to thetext. Tey range from interpretation of statistical techniques to addressing realproperty valuations in comparison tobusiness interest valuations.

NEW TO THIS EDITION

Although signicant additional mate-rial is contained in this fourth edition, cer-tain new segments merit special mention:

A chapter on distressed businesses;and the chapter on overall cost of capital has been expanded to exam-ine the impact on cost of capital inlight of the changes in market per-ception of, and the reduced avail-ability of, debt nancing.

A discussion on the cost of capitalfor fair value reporting of intan-gible assets.

Te chapters on company-specicrisk, common errors made in valu-ation, and advice from the authors

about dealing with specic cost of capital issues have been expanded.

Cost of capital in transfer pricinghas been updated to reect theimpact of cost of capital due to thenew IRS cost sharing regulations.

Te Workbook and Technical Sup- plement further assists practitioners inbetter understanding how to estimatethe cost of capital.

Te book is supplemented by ap-pendices that appear on the John Wiley & Sons website. Appendix I presentsan excerpt of a report submitted to theU.S. ax Court. Appendix II is the Valu-

Source valuation software. AppendixIII contains an extensive review of thestatistics discussed in Cost of Capital: Applications and Examples. Te web-site also offers Excel worksheets to as-sist the user in implementing the meth-ods discussed.

Tere is so much rich content thatspace limitations preclude mentioningall of it here. Tis extraordinary textwill do much to further the professionalpractice of all manner of valuation, par-ticularly with respect to the technically correct and inherently defensible deri- vation of the cost of capital.

You put yourself and your clientat risk if you fail to acquire and review this work.

Darrell D. Dorrell , MBA, CPA/ABV,CVA, ASA, CMA, DABFA, is a partner in Financial Forensics (www.nancial- forensics.com), a specialized forensic ac-counting practice based in Oswego, OR. Dorrell is a coauthor of Marketability DiscountsA Comprehensive Analysis ( Te Value Examiner , September/Octo-ber 2008). He served as a member of the Editorial Board of the Examiner for six years, until August 31, 2010.

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