Reprint: R1207L
The Association for Financial Professionals surveyed its members about the assumptions built into the financial models they use to evaluate investment opportunities. Remarkably, no survey question received the same answer from a majority of the more than 300 respondents. That’s a big problem—because assumptions about the costs of equity and debt profoundly affect both the type and the value of the investments that companies make, as well as the health of those businesses and the broader economy.
Citing the AFP survey results in detail, Jacobs and Shivdasani, of the University of North Carolina, argue that with trillions of dollars in cash sitting on corporate balance sheets, it’s time to look honestly at precisely what affects the cost of capital. They offer specific examples of the consequences that misidentifying the cost of capital can have; a rigorous primer for how to calculate terminal value, the number ascribed to cash flows beyond a project’s forecast horizon; and an online tool that allows you to input your own rates to see how terminal-value growth assumptions affect a project’s overall value. With this knowledge, you’ll be much better equipped to identify your true cost of capital.
