Cost of Capital Glossary

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Beta is the term commonly used for sensitivity to market risk. In the context of the Capital Asset Pricing Model (CAPM), beta measures the expected sensitivity of changes in returns of a security to changes in returns of the market.

Company Specific Risk

The uncertainty of expected returns arising from factors other than those factors correlated with the investment market as a whole.

Cost of Capital

The expected return appropriate for the expected level of risk. Also, commonly called the discount rate, the expected return or the required return.

Cost of Debt

The expected return to debt investors.

Cost of Equity

The expected return to common equity investors.

Cost of Preferred Equity

The expected return to preferred equity investors.

Equity Risk Premium (ERP)

The extra return that investors demand to compensate them for investing in equities rather than investing in risk-free securities. Also, commonly called the market risk premium.

Income Approach

A way of determining a value indication of an investment using one or more methods that convert the expected future economic benefits associated with an investment into a single "present value" amount.

Risk-Free Rate

The return available on a security that the market generally regards as free of the risk of default.

Size Premium

The difference between the actual historical excess return and the excess return predicted by beta that is attributed to the risk implied by the size of the subject company.

Weighted Average Cost of Capital (WACC)

It represents the market-capitalization-weighted cost of capital for both equity holders and debt holders.