Business Valuation Review Volume 35: Issue 2

In the 1st part of this series we focused on how appraisers and the real world have such differing views on ‘costs of capital,’ ‘capital access,’ and, thus, valuation. In Part I, entitled “Appraisers vs. Real World Debates: How many appraisers can dance on the head of the private capital market?,” I referenced that there is a considerable gap between reality and the hypothetical, which further limits the strategic value of business appraisals. In this article, we offer insights, data, and approaches to make cost of capital development more relevant.

In this article, we develop an enhanced corporate valuation model based on the implied cost of equity capital (ICC). We argue that the enhanced method extends the standard market multiples and discounted cash flow (DCF) methods to corporate valuation. Specifically, it incorporates positive aspects of the market comparables and DCF methods while mitigating the shortcomings of both. Unlike the traditional market comparables method, the enhanced method takes account of the full-term structure of earnings forecasts. Unlike the DCF method, it does not require estimation of the cost of equity capital. While other applications of the ICC, such as using it to estimate the cost of equity capital, are reported in the literature, our approach differs in that we do not treat the ICC as a discount rate, but rather as an enhanced multiple that allows estimation of equity value for a company based on publicly available information on projections and market prices for comparable companies and publicly available projections for the company being valued. As such, it avoids the complexity and uncertainty associated with estimating the cost of equity capital. In our empirical tests, we find the enhanced multiple method to be more accurate than either of the two traditional methods.

Practitioners commonly incorporate a size premium when developing their cost of capital estimates using the modified capital asset pricing model (MCAPM). This article is intended to correct common misconceptions about the size premium and demonstrate that data from recent periods support the continued use of a size premium.

The business valuation profession has seen remarkable advances in terms of how appraisers approach their work during the past twenty years—thanks in large part to Jim Hitchner, Shannon Pratt, and Jay Fishman. These gentlemen had devoted a substantial portion of their careers to furthering a body of knowledge by which others in the profession have benefited. Be it in speaking or writing, their commitment continues, and we should all be quite grateful.

Recently this trio collaborated in answering some of the more challenging questions we face—on a daily basis—in valuing closely held businesses. With a view toward consensus, Hitchner, Pratt,

Editor's Column

Part II: Appraiser vs. Real-World Debates: The Case for Using Private Capital Markets Data

An “Enhanced Multiple” Corporate Valuation Model: Theory and Empirical Tests

The Size Effect—It Is Still Relevant

Book Review

Book Review

From the Chair

Economics and Valuation…

Volume 35, No. 2 — Complete Issue

From the Editor

Customer Concentration: Good, Bad, or Ugly?

From the Chair

Delaware Valuation Decisions, 2021 to 2024

Volume 44, No. 1 — Complete Issue