Re: Cost of equity
Evan,
Have you had Damodaran at NYU? I was just flipping through one of his books today. How is he as a teacher?
Anyway, I'll stick to the part that I think we disagree on: the idea that market pricing does not determine cost of equity (or debt). The cost of equity is going to be how much the firm has to pay to acquire equity funding. When that firm is faced with a marginal project, how much will they be charged to finance that project via equity funding?
Looking at the stock price and (assuming you can estimate them) the expected future cash flows to equity holders will tell you what discount rate is currently implied by the stock price. If a firm were to issue new shares to finance the project, that's the discount rate that would presumably be applied to those shares as well.
I'm really surprised to see you disagree with the cost of debt. Suppose a firm issues a bond that specifies 10 annual payments of $4 million, plus 1 payment of $50 million at the end of 10 years. Looking at the price of that bond (the proceeds) will tell you the firm's cost of debt. If the firm receives $76,947,755, their cost of debt was 2%. If the firm receives exactly $50,000,000, their cost of debt was 8%. If the firm receives exactly $38,699,554, their cost of debt was 12%. It doesn't matter if buyers of the bonds were perfectly rational economic agents or if they were calculating the value of the bonds by multiplying their shoe size by their hat size - the proceeds from the bond issuance determine the cost of debt. How could it be otherwise?
The implied cost of debt may not be observable for illiquid offerings, but the theory is still the same - the discount rate that equates future cash flows to the current price is that firm's cost of debt (at least for that issuance).
Getting to the Berkshire meeting isn't hard. Every shareholder gets 4 invitations, so you can grab one from someone else who owns it. Because people were starting to sell them online last year, Berkshire started selling tickets on ebay to non-shareholders. $5 apiece, I think.
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