Cost of Capital ( Equity Only)




Cost of Capital
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Khalid Mahmood, Saudi Arabia

Cost of Capital ( Equity Only)

We recently were required to calculate a charge in order to determine the economic value added. We used CAPM to calculate the cost of equity. We are a debt free company. Since we are not a listed company so we took the beta of the comparable listed companies and used that in the CAPM. Treasury bills return was used for risk free rate. The overall return of the market was used for "return". The market return has to be lower or at par with the expected growth in GDP.
 
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Warren D. Miller, CPA, CFA
Strategy Consultant, United States
 

Treasury Bills as a Proxy for the Risk-Free Rate is Probably Incorrect

I have valued the equity of non-public companies for more than three decades. The risk-free rate should be equal to the expected duration of the investment in a non-public company. In most situations, that will be the yield-to-maturity on a 30-year U.S. Treasury bond. Unless the yield curve is inverted, the return on Treasury bills is much too low a risk-free rate. The result will be overstating the value of equity in the non-public company.

   

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