► UK Switzerland Germany
► Luxury Pharmaceuticals
► Swiss Banks
► Contact for detail info

Obermatt news 3-4 times a year

► What they say
► What we say

In traditional accounting using Generally Accepted Accounting Principles (GAAP), the interest paid on any debt  appears as a cost on corporate balance sheets, yet there is no corresponding cost for shareholders equity.  But of course there is an opportunity cost to equity financing, and shareholders expect a competitive return on their investment every bit as much as creditors do.  Including the Cost of Capital in measuring operating performance and economic profit is perhaps the single most important adjustment made to GAAP in EVA and value-based management.

There are two general methods for calculating Cost of Capital, the equity method and the entity method.  In the equity method, the Cost of Capital is simply the expected return on all invested equity.  In the entity method, the Cost of Capital is a weighted average of the cost of equity and the cost of debt: the weighted-average cost of capital (WACC).

The cost of debt can be identified directly from existing debt obligations or from the house bank.  The cost of equity cannot be measured directly and is typically derived from historic equity returns observed in the market.  One method of calculating the cost of equity capital is the Capital Asset Pricing Model (CAPM).  This model calculates cost of equity by multiplying a standard market risk premium by a risk factor beta (plus the risk free rate).  Since beta is difficult to measure for individual companies due to a lack of liquidity and data points, generic industry betas are often used to assess the appropriate beta, though more involved, company-specific calculation methods are possible.

Cost of Capital is used to calculate the Capital Charge in EVA.  Click here for more detailed information about calculating Capital Charge, including when to use each of the equity and entity methods.

Click here for more information about EVA Adjustments.
Click here for more information about Tax Treatment in EVA.
Click here for more information about calculating Capital Charge.

Click here for the following section on EVA sub-metrics: the Value Driver Tree.
Click here for the final VBM section on value-based incentive compensation.

Recommended Readings: EVA by Stephen F. O'Byrne, Competitive Value Management by Hermann J. Stern