Healthcare Cost of Capital Handbook

24 Pages Posted: 8 Mar 2004 Last revised: 2 Nov 2011

Abstract

Determining your weighted average cost of capital involves a number of measurement issues . . . we:

- Normalize the 10 year risk free rate to about 5%, looking forward on the swap curve and also comparing with 30 year Treasuries

- Estimate the market risk premium to be about 5%

- Present several methods to derive reliable estimates of beta including modified direct regression, portfolio regression, constructed betas, etc.

- Adjust the cost of debt for an expected value of the tax shield using an options framework as a proxy

- Approximate target capital structures from the trend in your market weighted mix of debt and equity

- Decompose hybrid financing instruments into their respective components for determining your weighted average cost of capital

Global investments do not contribute as significantly as one might expect to the cost of capital but do bring their own set of measurement issues:

- Inflation expectations, or currency risk, if carried in the cashflows must also be incorporated into the discount rate, based on expected inflation

- Sovereign risk, essentially unexpected inflation and other political risks, are systematic risks - chronic recurring risks that should be incorporated into the discount rate. We estimate this premium from sovereign bond rating premiums, Eurobond yields, and stripped Brady bond yields

- International capital costs, especially in softer currencies, can be a moving target that makes their application require judgment

- Other international risks and costs should be incorporated into the cashflows and sensitivity analysis of the investment analysis

Suggested Citation

Pettit, Justin, Healthcare Cost of Capital Handbook. Available at SSRN: https://ssrn.com/abstract=463020

Justin Pettit (Contact Author)

IHS Markit ( email )

200 Connecticut Avenue
Suite 300
Norwalk, CT 06854
United States

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