Should a Private Cost of Capital Method replace CAPM and BUM?


Most appraisers recognize the judgments and assumptions built into the process of converting measurable public market data into proxies for private company valuation. Capital asset pricing needs to be “modified” with a series of adjustments to the cost of capital figures derived from the public markets.  This standard valuation process that has some financial theory risks but it has been implicitly sanctioned by USPAP, SSVS-1, and particularly by Revenue Ruling 59-60 which justifies valuation methods based on data from actively traded stocks.

Rob Slee (Robertson & Foley, Charlotte, N.C.) and John Paglia (associate professor of finance at the Graziado School of Business and Management at Pepperdine) are two of the experts who have never been comfortable with the theory that public company data can be substituted for private value; both have been publishing on this subject for a number of years. Slee has identified a long list of contradictions arguing against this practice: public and private markets have different risks and returns, liquidity, access to capital, pricing mechanisms, holding periods, and transaction costs.

A review of the latest Pepperdine study appears in the August BVU, available today.


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