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When you’re looking to buy or sell your practice, you’ll often find the term "cost of capital" buried in a valuation. Let's demystify this concept along with other related terms. Cost of Capital (often abbreviated CoC) is a term often found in dental practice valuations formulas and is often denoted as \(r\). This \(r\) is used because CoC plays the more general role of required rate of return in those formulas. Here's the simplest form of these formulas: $$\mathbf{\text{Practice Valuation}} = \frac {\text{Expected Next Year Income}} {r}$$ In this context, required return (and thus CoC) expresses the financial return prospective buyers of a practice expect to receive. The way CoC does this is by discounting the future income expected from a practice to arrive at its valuation. Because CoC discounts future income in this way, yet another similar term, discount rate , is often used to refer to the same concept as CoC. When a practice has debt holders (for example, a ban

So what's better for practice valuation: a higher or lower Cost of Capital? Generally speaking: $$\text{Higher Cost of Capital} \Leftrightarrow \text{Lower Valuation}$$ $$\text{Lower Cost of Capital} \Leftrightarrow \text{Higher Valuation}$$ But to really get to the heart of the answer, you have to understand the two major factors affecting Cost of Capital for a dental practice: 1. Income Sustainability: Income sustainability factors into the concept of Cost of Capital inversely as an implied estimate of the sustainability of a practice's income. In other words: $$\text{Less Sustainable Income} \Leftrightarrow \text{Higher Cost of Capital}$$ $$\text{More Sustainable Income} \Leftrightarrow \text{Lower Cost of Capital}$$ Understood this way, a higher Cost of Capital implies that a practice must work harder to maintain its current level of income. Some reasons for a high Cost of Capital include low patient retention, high cost of new patient acquisition, contracting local market,

Once you've understood the term Cost of Capital , you can use it to derive or justify a valuation for a dental practice. Let's work through an example. Let's say your practice brought in $200,000 of Net Income (NI) this year and is expected to bring in a similar NI next year. You just received an offer for $2,500,000 and will sell your practice debt free with the buyer being responsible for their own financing. Should you take the offer? Reviewing our list of valuation formulas, we are best off using the perpetuity valuation formula since our NI is not expected to change: $$\text{Valuation} = \frac{\text{Next Year Net Income}}{\text{Cost of Capital}}$$ Given our NI, the implied Cost of Capital from the offer can be calculated by solving: $$\$\text{2,500,000} = \frac{\$\text{200,000}}{\text{Cost of Capital}}$$ $$\Rightarrow \text{Cost of Capital} = 0.08 = 8.00\%$$ As Cost of Capital is a number driven by negotiation, its value is driven foremost by industry benchmarks. Since

By definition, a sunk cost is any cost you've made in the past. Problems with sunk costs arise when you have to make new plans, and they can easily get in the way of your best interests. For example, let's say you recently bought an existing dental practice in a small town. The patient pool was great on day one, but about a month later, the town's largest employer announced plans to relocate. It's been a year since then, and as the town's jobs have moved, so have the majority of your patients. What now? Whatever your choice, if the time and money you've already invested influences your decision, then sunk costs have unfortunately muddled your thinking. Fascinatingly, this not so contrived example was put to the test in 1993 by two Stanford professors, who, using ADA data, found that dentists often fell victim to sunk costs , especially dentists with local monopolies. Remember, that as a business person planning ahead, it's critical to stay focused on the ful