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Hey Joe...

I haven't read Mr. Heiserman's book yet (but it's on my short list), and I certainly cannot speak to his viewpoint... and as much as cost of capital caves my head in, I think I can at least point out why the general consensus is to use market value and not book value of equity.

As I understand it in general terms...

The arguments for using book value of equity are many... among them...

- it's easy to obtain straight off the balance sheet
- it has some tangible meaning, whereas market price is simply what's paid today
- if you use market value of equity to determine the debt/equity weighting to get your cost of capital... and then you use that cost of capital to determine your intrinsic value of the company... you're using the market value to determine an intrinsic value that may tell you the market value is wrong, meaning your intrinsic value is wrong since it was based in part on market value (wait... did I go around that circle too many times?)

So... given all this, how do you reconcile the contradiction between book value of equity and market value of equity, and why would you use market value? The bottom line (at least according to Damodaran) is that if you were to buy the entire company outright today, you'd have to pay market value for equity regardless of what shareholder equity on the balance sheet is. So, despite the convincing arguments above, you have to use market value of equity to determine intrinsic value.

He also points out an added bonus... you'll never have a negative market value for equity. Book value for equity can be negative. Good luck working with that.

That said, this is all purely academic in my (simple) mind. I may simply be too slow to calculate a useful beta, hence cost of equity is meaningless, hence weighted cost of capital is meaningless (to me)... so I use the often cited "hurdle rate" and focus my attention elsewhere in evaluating a company. I probably would fail out of business school though, so what do I know.

Anyway, hope that gives some food for thought... or at least a big fat grapefruit for someone more knowledgeable to shred apart while providing their own answer.

kevin
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