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Toward A Reliable Cost of Capital

Author(s): Jeremiah U. Idialu | Amos O. Arowoshegbe

Journal: Current Research Journal of Social Science
ISSN 2041-3238

Volume: 5;
Issue: 4;
Start page: 112;
Date: 2013;
Original page

Keywords: Capital budgeting | Cash flow estimation | debt capital | equity capital | net present value | WACC

This is study is designed to provide basis for determining a reliable cost of capital. Corporate finance textbooks typically devote several chapters to the problems of capital budgeting, cash flow estimation and the determination of a firm’s cost of capital. However, it can be difficult in practice to obtain reliable estimates of the inputs required to perform capital budgeting as recommended by the textbooks. Also, the Weighted Average Cost of Capital (WACC) is commonly presented in a way that creates difficulties in calculating the estimate. The most cumbersome component of WACC estimation is the cost of capital. Practitioners therefore have to rely on more abstract and indirect methods to estimate cost of capital. In the study, we reviewed alternative methods of deriving reliable estimates of cash flow and cost of capital. Our review of relevant literature reveals procedures that will lead to methods that are less intensive in terms of the time and computations required to calculate a WACC estimate. We also establish methods that require fewer inputs and/or calculations that are based on subjective judgments of the analyst or the firm’s management.
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