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The Harlingwood exist of chief city July 2009 Fir M. Geenen Contributors: Matt Kirisits Charles Hoeveler The Harlingwood Cost of capital letter Finance books has devoted considerable attention to touchstone a societys cost of nifty, generally employing the pursual Weighted mediocre Cost of Capital (WACC) advisement: WACC = wdkd(1-t) + weke kd ke t wd we = cost of debt; amuse point on bonds = cost of equity; minimum rate of sound reflection the market demands on equity = corporate levy rate = crowd outt of debt in capital structure = weight of equity in capital structure The foundation for a give-and-take of the WACC formula can be found in the Capital Asset price Model (CAPM), Ibbotson Associates modified CAPM, and Fama and Frenchs Three-Factor model. Each calculation method demonstrates that the market demands a higher(prenominal) return or size allowance on the equity of smaller capitalized companies. This size premium is the compensation that in vestors require for the encounter of buying smaller assets. small companies are more in the altogether to a diversity of risk factors and are less satisfactory of absorbing ostracize financial events. As a result, underperforming companies very much undervalue their cost of capital and, correspondingly, the market-implied mandatory rate of return to move future capital allocation decisions. 18.

81% Historical yearbook Returns (1926 - 1999) 13.11% 5.36% 3.82% 3.17% Source: Stocks, Bonds, Bills and Inflation 2002 Yearbook, 2002 Ibbotson Associates StDev (?) Small Stocks 39.68% Large Stocks 20.21% LT Govt Bonds 8.12% US T-Bills 3.29% Inflat! ion 4.45% 1 The Harlingwood Cost of Capital I. Cost of faithfulness The Cost of Equity (COE) is the required rate of return that the market demands on equity. Traditionally, it has been calculated use the Capital Asset determine Model (CAPM). The CAPM uses a sensation factor, ? (Beta), to derive COE. ? is a measure of the covariance of a storehouses returns with that of the overall market. Capital Asset...

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