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Standard models on firm valuation, incorporating risky debt, assume a certain tax treatment of a cancellation of indebtedness (COD). Most valuation procedures solely discuss two polar cases: either the COD is strictly taxed on its entirety or not taxed at all. Considering the predominant national tax jurisdictions in G7 and many other countries, this assumption is far from being realistic. We model a state dependent taxation of a COD considering the firm's state in default and further contingencies, including a partial taxation. We show how to include this stochastic interdependency into the pricing of the value of the tax shield and the WACC. Compared to the case of full taxation of a COD this potentially increases the value of tax savings and decreases the discount rate, since less taxes are paid in states with exceptions of a tax on a COD, vice versa for the case of no taxation on a COD. Furthermore, in case of an exemption from taxation of a COD, pricing equations depend on the distribution of total losses on interest and principal payments.

This article attempts to clarify the effect of risk management on a company's cost of capital in the spirit of the traditional M&M/CAPM model. The traditional cost of capital model can and should be used to find the hurdle rate for a company's operating assets, since it can be applied regardless of the composition of the firm's non-operating assets or its risk management policy. The author's main message is that if a firm manages idiosyncratic risk, the correct cost of capital for the operating investment is not the firm's enterprise WACC, but rather the required return on the assets being funded. Using the case of a company with a single line of business that is evaluating an investment opportunity, the author demonstrates how to adjust the firm's overall WACC to find the cost of capital for the operating assets to be acquired.

The decarbonisation of hard-to-abate sectors globally will require significant volumes of carbon-free hydrogen. An investigation has been performed to determine the cost at which hydrogen can be generated by electrolysis using renewable electricity in South Africa between 2020 and 2050; stored in suitable carriers: liquid organic hydrogen carrier (LOHC), cryogenic liquid hydrogen, and ammonia; then shipped to Japan and EU. Renewable electrolysis hydrogen is produced at lowest cost in South Africa using electricity generated by a hybrid fleet of wind and single-axis tracking PV power plants, using large-scale alkaline electrolyser plants. Hydrogen is converted and stored at lowest cost as LOHC, but delivered to Japan at lowest cost as ammonia. It may be delivered to Japan at or below the Japanese target cost of US $3/kg or €2.50/kg by 2030 (when bulk imports are planned to begin) in one of two ways: firstly by reconverting the ammonia carrier to gaseous hydrogen, provided that concessionary finance allows a maximum weighted average cost of capital (WACC) of 3% the for renewable power and electrolyser infrastructure, or secondly as ammonia for direct use (without reconversion to gaseous hydrogen), provided concessionary finance allows a maximum WACC of 6%. In any event, the landed target price may be met for gaseous hydrogen by 2040 (when hydrogen imports must be carbon-free) at a WACC of up to 6%.

The development of resource rent in Icelandic fisheries has been charted since the introduction of the individual transferable quota system in 1990. An estimation of the rent capture of the fishing fee, which is a form of resource rent taxation, is also presented. Two methods were applied to calculate the resource rent. One method is based on the weighted average cost of capital of the Icelandic fishing industry, and the other method involves comparing the return of the capital of fisheries to the general aggregate Icelandic economy. The findings indicate no presence of the resource rent in Icelandic fishing and processing until 2008. Since that time, the rent has been, on average, 16–19% of the export value of the fishing industry, depending on the methods that were applied. The most obvious reason for the long delay before the rent appeared is the almost continual decline of fish catches from 1990–2008. The industry was rationalized during that time, but the rationalization kept up only with the reductions in landings; thus, no resource rent was produced. The rent appeared when the catches started to increase in 2009. In addition, the exchange rate and the weakening of the Icelandic krona were major contributors to the emergence of rent after 2008. The fishing fee captured approximately 13–15% of the calculated rent from 2009. The fee has been relatively modest but was significant in 2016, when it was increased and set at approximately 26–29% of the estimated resource rent of Icelandic fisheries.

With the increasing share of renewables in electricity generation in Europe, implied economy-wide macroeconomic feedbacks and spill-over effects to other sectors and actors are of rising importance. We quantify the macroeconomic effects of a large-scale expansion of wind and photovoltaics (PV) in Europe, employing a global multi-regional multi-sectoral computable general equilibrium (CGE) model. We place special emphasis on electricity market integration costs, which have so far been neglected not only in most bottom-up technology comparisons, but also in macroeconomic studies. We find that the societal welfare effects of a large-scale expansion of wind and PV tend to be positive; however, when integration costs are taken into account, positive welfare effects are either much smaller or even become negative, depending very much on regional characteristics, such as the prevailing electricity mix, weighted average costs of capital (WACC) or capacity factors. We also show that macroeconomic feedback effects raise generation costs above what is anticipated from a bottom-up perspective, since the high capital intensities of renewable electricity generation technologies drive up economy-wide capital prices. This may imply that they are no longer competitive when installed at large-scales.

The current position of the business can be verified through ratios analysis. According to this analysis managers, creditors, and investors can receive valuable information about the effectiveness and efficiency of the operations. Managers by using especially profitability, operating, and asset utilization ratios can maintain a fairly accurate perception of the financial health of their business. Different types of ratios can help them as they are indicator of well goals are being achieved. When actual results can not meet the standard set, then, ratios indicate where the problem may be. There are different types of ratios. Liquidity ratios are current and quick asset ratios. Profitability and operating ratios are return on asset, gross profit margin and net profit margin. Gearing ratios are divided into debt to equity ratio and number of times interest earned. There are different shareholder investment ratios such as return on shareholders, earnings per share, price earnings ratio, dividend yield and dividend covers. Under asset utilization ratios, we have the net asset turnover, debtor collection period, stockholding period and creditor payment period. Investment appraisal is a process which assists mangers to take decisions and evaluate the future success of a project in terms of profitability, suitability, and compatibility with company objectives. The value of money changes with time. Money received today has a different value from money received in the future. the investors before making any investment must take into consideration that different types of securities will have different kinds of risks. The several sources of risk can be classified as: interest rate risk, market risk, inflation risk, business risk, exchange rate risk, financial risk, country risk, and liquidity risk. No investment will be made unless the expected rate of return is high enough to compensate the investor for taking extra risks. In general, it is believed that the higher the perceived risk associated with an investment opportunity, the higher should be its expected return to persuade an investor to accept the investment opportunity. Investors are risk averse, namely that they want to reduce their risk through a diversified balanced portfolio. This leads us to modern portfolio theory, which was developed by Markowitz (1959). Arbitrage pricing theory, APT, is a more general approach to asset pricing because it allows for the possibility that many factors can be used to explain security returns. The assets of a company are financed by either debt or equity. After calculating the cost of capital for equity and debt, then, we combine them in a form of weighted average to calculate the final weighted average cost of capital. The reason of measuring the weighted average cost of capital is to find how much interest the company or the government has to pay for every Euro it borrows. Factors that affect the cost of capital are the capital structure of the company, the dividend policy, the investment policy, the level of interest rates and the tax rates. Managing the working capital of the business is very important step that will prevent the shareholders from bankruptcy. It is very important to control short and long – term cash in relation to short and long – term liabilities. The relationship between fixed and variable costs is very important to determine the amount of leverage that the company will use. Leverage is determined by the profit changes due to changes in sales. The proportion of costs in the capital structure of a company determines the level of leverage that the company will use. The valuation of a derivative product is determined by changes of the main asset. They are risky products and due to the leverage effect they provide high positive or negative returns. Business valuation is an important measure in case that the shareholders seek short- term liquidity to finance their debt. The most common measures are dividend yield, price earnings ratio and net asset value.

This study investigates the impact of issuing green bonds for environment protection initiatives on the corporate cost of capital. Accounting for nearly 2 percent of corporate bonds annual issuances during 2016-2020, in China, green bond issuance plays an essential role in sustainable development. By matching green bonds with conventional corporate bonds based on propensity matching scores, we find a 24.9 bps negative green premium on average. We hypothesize that green projects help lower the corporate cost of capital in three channels: (i) reducing information asymmetry, (ii) improving security liquidity, and (ⅲ) lowering bond issuers’ perceived risk. Our empirical findings are consistent with these expectations. Specifically, we find that the corporate cost of capital—regardless of whether it is measured by the implied cost of capital or by the weighted average cost of capital— is significantly lowered after the issuance of green bonds through these three channels. Collectively, the findings suggest a specific venue for environmental protection initiatives that affects s company’s value positively.

This paper examines the impact of tax reforms on EVA on the non-financial S&P 500 firms by examining how ROIC, WACC, and growth in Invested Capital were affected by the 2017 tax reform through paired sample t-tests. We find that while the tax cut has increased ROIC-WACC, it hindered growth in Invested Capital. Furthermore, due to the distribution of ROIC-WACC across the sample firms being negative on aggregate, the increase in ROIC-WACC, which is still a negative figure, multiplied by a growing capital base, resulted in a decrease in aggregate EVA. This leads to the discussion of a critical invested capital growth rate, at which a given change in ROIC-WACC results in no change in EVA, and a discussion of how different firms have their EVA affected differently depending on their ROIC-WACC and Invested Capital growth rate.

Much contention still exists around the discount rate to be used in the determination of the net present value (NPV) of a mining operation’s discounted cash flows, so much so that it is typically deemed simpler to just use a single “corporate rate” that satisfies the targeted project’s return associated with the investment capital outlay. This targeted return will supposedly incorporate the actual cost of capital, being the weighted average cost of capital (WACC), incorporating the capital asset pricing model (CAPM) for the equity component and the cost of debt (the inter-bank lending rate with an additional lending margin), plus some gut-feel or indeterminate additional return factor to appease the project owners and its associated shareholders. This additional project risk being captured in a discount rate is contentious. In addition, while there may be some argument to justify why a single, all-encompassing discount rate should be used, notably for a short-life operation, can a single discount rate actually be justified? Can a single rate be equally justified for medium and long-term operations? Importantly and accepting that the WACC and hence the discount rate vary over time, how does the risk and the uncertainty associated with a mining project get factored into the valuation, and should these factors remain static, or should they be considered separately and also be varied over on operation’s life?

In this paper we outline how to value private companies and work through a real case study. The corporate finance and valuation techniques on display can be used to value any private company or project that is illiquid with little or no market data. Together with this paper we provide the full background information for the case study, including consolidated balance sheet, cash flow and income statements and an Excel workbook with a full valuation breakdown . Two valuation approaches are presented. The first approach is called ‘multiples’ and requires we first identify sensible comparable companies with public data and can serve as a reasonable proxy for our underlying firm or project. Known proxy enterprise values are converted into multiples of EBITDA and extrapolated to value the private company or project of interest. Enterprise value can be measured as a multiple of sales, earnings, EBITDA, EBIAT and many income factors. Typically practitioners measure enterprise value as a multiple of EBITDA to exclude sales margin, capital structure, debt and leverage and other idiosyncratic biases. The second valuation method takes a discounted cash flow (DCF) approach. This approach is forward looking; it projects and values the future cash flows of a company. This method lends itself to richer analysis compared to the multiples approach, but relies heavily on assumptions surrounding cash flow projections, growth rates and the weighted average cost of capital (WACC). The WACC acts as a yield or discount factor and is required to value the cash flows of the firm or project (Burgess, 2020). Finally we compare the prices from several different approaches to arrive at a suitable price range. It is important to note that all approaches involve assumptions and approximations of some kind. Therefore practitioners seek to establish a reasonable price range rather than a single price. Transactions however must take place at a single price and law suits are a popular commonplace negation tactic to squeeze for additional value.

As interest rates on Government Bonds have decreased, some analysts and consultants in Europe and in the US are using what they call “Normalized Risk-Free rate”. We show several inconsistencies and errors in the use of “Normalized Risk-Free rate”. Section 5 is a short case that may be used in class. It contains 26 interesting comments.

We reconcile the empirically flat relation between historical betas and stock returns (flat security market line) with the common usage of the CAPM based on historical betas in valuation. Analysts bias cash flow growth expectations upwards for high-beta firms, so that the value-reducing effect of higher historical systematic risk cancels out and buy/sell-recommendations remain unrelated to beta. The association between beta and growth overestimation is driven by estimates conventionally used in the industry (e.g., Bloomberg betas), suggesting that analysts adjust growth expectations to offset beta's valuation effects, instead of exhibiting a coincidentally higher overoptimism for higher-beta firms.

Risk is a vital concept to grasp when investing in a firm or project. It is a key ingredient required to evaluate the cost of capital and perform a valuation. The capital structure used to finance a firm or project and specifically the amount of leverage and debt financing employed must be accounted for to correctly assess a project’s risk and perform an accurate valuation. There are different measures of risk available to us to assess the risk. In this paper we review common risk measures used by practitioners and give an overview of the CAPM beta which measures a firm’s systematic risk and assumes that investors are not rewarded for firm specific risk (Berk and DeMarzo, 2016). We review the CAPM model commonly used in corporate finance and show how to calculate beta. Furthermore we discuss how risk increases with leverage and the level of debt financing used to finance a company or project, which consequently increases expected returns (Brealey et al, 2014). We discuss how CAPM beta can be calculated as the co-movement of returns with the market and/or equivalently as the slope of a regression analysis. For firms and projects that are illiquid and/or have no public data we can imply beta risk from comparable company data, however we are required to unlever and relever beta’s to remove leverage effects from the comparables and introduce the leverage effects of the target to give a reliable indicator of beta risk (Koller et al, 2015). Not only is CAPM beta useful to assess the risk of a firm or project, but it is essential to calculate the weighted average cost of capital (WACC). This is the expected return investors require to invest in a project and incorporate the correct level of risk. Consequently CAPM beta risk is a key ingredient required to value of a firm or project and perform a discounted cash flows (DCF) analysis, see (Burgess 2020a), (Burgess 2020b) and (Burgess 2020c).

Critics of recent regulation to increase minimum bank capital requirements contend that this policy will increase the cost of doing business for banks. We investigate the potential impact of heightened capital requirements on banks’ cost of capital. In the cross-section, banks’ cost of equity, measured by the implied cost of capital (ICC), and banks’ cost of debt decline when equity capital increases. The negative association between capital and banks’ ICC is stronger after the onset of the financial crisis, consistent with prior work suggesting that equity is more valuable during periods of financial distress. The negative association between capital and banks’ cost of equity and debt, compensates for the difference in the costs of these sources of financing. As a consequence, the overall cost of capital remains unaltered when capital increases. Thus, our findings do not offer support the claim that additional equity has a negative impact on credit because equity increases banks’ cost of capital. An exception to these findings is found in the sample of large banks. There is no discernible association between capital and the costs of equity and debt of large banks and their WACC increases when they substitute debt with more expensive equity.

Terminal Value (aka Horizon Value) is the value of a firm when the firm is expected to grow at a constant rate forever. The method to calculate value a constant-growth firm is sometimes called Capitalization. Currently, and for decades, the primary method, if not the only method, to calculate Terminal Value is a formula commonly known as the Gordon Growth Model (GGM). In addition to the constant growth assumption, Gordon Growth Model assumes “constant capital structure” which results into “Constant WACC” (Weighted Average Cost of Capital) as a discount rate. This paper will show following: 1) The “constant WACC” assumption of the Gordon Growth Model implies that the capital markets will accept “Dividend First” financing terms. However, the capital markets function with “Debt First” financing terms. When a firm operates with “Debt First” financing terms, but the value is based on “Dividend First” financing terms, the equity IRR is less than expected. This means GGM overvalues a firm. And, such over valuation is material, 10 to 50% and sometimes even more. 2) Introduce Advance Growth Model (AGM) to value a constant-growth firm assuming capital markets acceptable “Debt First” financing terms. AGM formula is a generalized formula for Terminal Value; AGM value is equal to GGM value if GGM assumptions are plugged into the AGM formula. GGM formula is very elegant; AGM formula is very complex even though it has only 3 more input variables. A free spreadsheet with GGM and AGM formulas is available in the main article.

The essence of EVA（Economic Value Added） is the "economic" profit generated by enterprise operation. In contrast to the "accounting" profit that people attach importance to, EVA concept reflects that the shareholder capital occupied by the enterprise also has a cost, so the cost of equity must be taken into account when measuring the performance of the enterprise. The formula of EVA calculation is written as NOPAT - (Total Assets - Current Liabilities) * WACC. A positive EVA implies the company is currently creating extra value for the shareholders and vice versa. The following content will discuss if EVA can be a good indicator of the quality of the investment and how EVA can be used in the stock selection. We will focus on the relationship between the EVA value and the stock return by testing the veracity of different literature resources and apply the regression test in the SAS tool.

Modigliani and Miller theory forms the theoretical foundation of corporate finance. Yet Modigliani and Miller theory was derived from a very special case of cash flows. Weighted Average Cost of Capital (WACC), which is part of the Modigliani and Miller theory, plays a fundamental role in capital structure decision and asset valuation. Empirically, asset valuation calculated from cash flows discounted by WACC almost always differs from the sum of debt and equity values. We derive asset valuations for more general cashflows. Only when the debt equity ratio is constant over time, valuation by WACC is equal to the sum of debt and equity values.

This study uses the universe of US public firms to examine the impact of credit default swap (CDS) trading on a firm’s cost of capital during the period 2001–2018. Our results robustly show that the inception of CDSs causes a significant reduction in a firm’s weighted average cost of capital (WACC). We also find an increase in the number of analysts who recommend buying CDS firms’ stocks post-CDS trading, suggesting an improvement in the firms’ information environment. Further analyses reveal that highly levered firms tend to reduce their debt weight, while firms with low leverage increase their usage of debt. In equilibrium, we find a marginally decreased net debt issuance post-CDS trading. Moreover, CDS referenced firms adjust their debt placement by using more arm-length debts, while they simultaneously decrease the usage of revolving credits and term loans from banks. The change in capital financing choices may be ascribed to the improved information environment and reflects the fact that CDS trading increases debt renegotiation costs and simultaneously reduces capital supply side frictions.

This paper provides a theoretical and empirical analysis of alternative discount rate concepts for computing LGDs using historical bank workout data. It benchmarks five discount rate concepts for workout recovery cash flows to derive observed Loss rates Given Default (LGDs) in terms of economic robustness and empirical implications: contract rate at origination, loan weighted average cost of capital, return on equity, market return on defaulted debt, and market equilibrium return. The paper develops guiding principles for LGD discount rates and argues that the Weighted Average Cost of Capital (WACC) and market equilibrium return dominate the popular contract rate method. The empirical analysis of data provided by Global Credit Data (GCD) shows that declining risk-free rates are in part offset by increasing market risk premiums. Common empirical discount rates are between the risk-free rate and the return on equity. The variation of empirical LGDs is moderate for the various discount rate approaches. Furthermore, a simple correction technique for resolution bias is developed and increases observed LGDs for all periods, particularly recent periods.

The most used methods for valuing companies by Cash Flow Discounting are equity cash flow, free cash flow, capital cash flow and APV (Adjusted Present Value). Only APV does not require iteration All four methods, if properly applied, always give the same value. This result is logical, as all the methods analyze the same reality under the same hypotheses; they differ only in the cash flows or parameters taken as the starting point for the valuation. Many valuations are incorrect because the authors do not iterate and, therefore, the four methods do not provide the same value.

This paper presents a real valuation performed by a well-known investment bank, with two common errors and with two very different values for the equity of a firm: a) €6,9 million calculating the Present Value of expected free cash flows (FCF) discounted with the WACC rate and then, subtracting the value of debt; b) €4,2 million calculating the Present Value of expected equity cash flows (ECF) discounted with the Ke rate (required return to equity). We identify the two main errors of the valuation of the investment bank and calculate the “right solution”: €5,9 million. The paper also contains 210 answers and 56 comments from readers to the questions of the previous paper (The Most Common Error in Valuations using WACC https://ssrn.com/abstract=3512739 that did not contain the “right solution”.)

To value shares there are two usual methods that, if properly applied, provide the same value: 1/ Present value of expected free cash flows (FCF) discounted with the WACC rate and then, subtract the value of debt; and 2/ Present value of expected equity cash flows (ECF) discounted with the Ke rate (required return to equity). Both valuations must provide the same result because both methods analyze the same reality under the same hypotheses; they differ only in the cash flows taken as the starting point for the valuation. But in many valuations performed by investment banks, analysts, consultants, finance professors… both methods do not provide the same value. This paper presents a real valuation performed by a well-known investment bank, with two very different values: €6,9 million using method 1/, and €4,2 million using method 2/.

This paper attempts to show how the cost of capital influences the non-linear interaction between investment and Tobin's q by affecting the probability of regime-switches. Treating the US non-farm, non-financial corporate sector as a representative firm and calculating a cost of capital by weighting the respective costs of equity and debt financing, our estimation results shed light on the periods of low capital expenditure, which are picked up neither by Tobin's q nor by the real interest rate. The findings challenge the concept of the ‘irrelevance of dividends/capital structure’.

Upon extracting and quantifying relevant hedge information from the narrative section of European banks annual reports, this paper examines the impact of such information on cost of capital [as measured by weighted average cost of capital (WACC), cost of equity (COE) and cost of debt (COD)]. Using a sample of 1885 bank-year observations from 19 countries, we find that textual hedge disclosure leads to a significant reduction in WACC, COE, and COD; thus explains a substantial portion of variation in cost of capital. Further, we find that these results are stronger in countries with high corruption and financial openness. Our results are robust to several controls and model specification. Collectively, our findings enrich prior evidence which examines the economic consequences of hedge disclosure.

Offshore wind is one of the renewable energy technologies with the largest potential. However, it still not competitive in costs with other similar technologies, and hence requires public support, which has been mostly done recently through auctions. These auctions have achieved seemingly very large cost reductions in the last years. However, some results may be misleading, because of the large differences between auctions in terms of their design and of the amount of costs explicitly or implicitly assumed by governments. In this paper we estimate the underlying CAPEX behind the most recent auctions’ winning bids for a consistent set of assumptions, but accounting for their different designs. Our results show that the cost reductions achieved are indeed real, and larger than shown before. We obtain costs reductions of 50% between 2020 and 2026, and a rather steep learning curve. This general reduction trend is robust to changes in our assumptions. However, our results also show that CAPEX estimates are very sensitive to WACC rates, capacity factors, or market prices (when auction designs rely on a larger market price exposure). On the other hand, wind farm size and distance to shore show low correlation with CAPEX. Finally, we also show that, if the current trend in cost reduction continues beyond 2026, offshore wind might achieve cost competitiveness by 2030. This in turn may point out to a higher share of offshore wind in future energy scenarios.

This paper characterizes capital taxation and public debt policy in a quantitative macroeconomic model with an impatient government and uncertainty. The government has access to linear taxes on capital and labor, and to non-state-contingent bonds. Government impatience generates positive and empirically realistic long-run levels of both capital taxes and public debt. Prior predictive analysis shows that the simulated model matches the distribution of both variables in a sample of 42 countries, alongside other statistics. The paper then presents econometric evidence that countries with higher political instability, used as an approximation of unobservable public discount rates, have both higher capital taxes and debt.

We examine the impact of political risk in the MENA region on the cost at which firms can raise capital. Using the implied cost of equity as a measure of the cost of capital and ICRG's political risk rating as a proxy for political risk, we find that political risk results in a higher cost of capital. Economically, our results suggest that a one standard deviation increase in the political risk index is associated with a 450 basis points increase in the cost of equity capital of MENA firms. Our results are consistent across a battery of robustness checks. Our findings have important policy implications that are relevant to the MENA region and beyond.

The research uses unbalanced panel data from all non-financial listed firms during the period 2007–2012 to investigate the effect of capital structure on firm performance in Vietnam. The results indicate that all debt ratios have significantly negative relation to firm performance. This outcome is not in accordance with most studies conducted in developed countries, which posit a positive relationship between capital structure and firm performance; however, it is consistent with some studies in the context of developing markets. This paper argues that in typical developing market like Vietnam, the benefits of debt from tax saving may be less than financial distress cost. In addition, the monitoring role of debt is not substantial because of severe information asymmetry and under-developed financial system. Our research results are robusted by using different approaches.

This paper investigates the relationship between employee stock ownership and the cost of capital, the main determinant of shareholder value creation computed through economic value added (EVA). By reducing agency conflicts within the firm, we hypothesize that employee share ownership reduces the firm’s cost of capital by affecting its two components, i.e. the cost of equity and the cost of debt. We test this hypothesis in France, a leading country in terms of employee ownership, based on a panel of the 120 largest listed companies for the 2000–2011 period. We find: (i) no significant relationship between employee stock ownership and the cost of equity; (ii) a negative curvilinear relationship between employee stock ownership and the cost of debt; (ii) a negative curvilinear relationship between employee stock ownership and the weighted average cost of capital. These results suggest debtholders regard ESO as positive as long it is moderate because it shifts risk from them to employees and that this effect is still perceptible in the weighted average cost of capital.

This paper studies research and development (R&D) investment and accumulation of firm-specific knowledge capital (i.e., human capital) in the presence of debt market frictions, highlighting the macroeconomic implications. Empirically, R&D investment and knowledge capital are negatively correlated with debt at the firm level, which is in contrast with the positive relationship between physical investment and firm debt. I propose a new model to account for these facts: Firms accumulate firm-specific knowledge capital through R&D investment. However, knowledge capital – different from physical capital – cannot be used as banking collateral. Firms with high R&D investment opportunities rely more on internal finance and less on external debt. The model is quantitatively consistent with empirical facts along several dimensions. Based on the model, I then study the implications of two industrial policies. A practice that encourages using intellectual property as collateral for bank loans has a relatively small effect. I recommend a policy of tax credits for R&D investment. In fact, this policy can increase output by more than 5% and welfare by more than 3% in the long run.

This paper evaluates the effects of capital controls on firm-level stock returns and real investment using data from Brazil. On average, there is a statistically significant drop in cumulative abnormal returns consistent with an increase in the cost of capital for Brazilian firms following capital control announcements. Large firms and the largest exporting firms appear less negatively affected compared to external-finance-dependent firms, and capital controls on equity inflows have a more negative announcement effect on equity returns than those on debt inflows. Overall, the findings have implications for macro-finance models that abstract from heterogeneity at the firm level to examine the optimality of capital control taxation.

Significant renewable energy (RE) investments have to be implemented in order to achieve the ambitious RE targets set in the EU for 2020 and beyond. Moreover, a great amount of capital has to be leveraged, as these projects are followed by high investment and financing costs. Main aim of this paper is the provision of a comprehensive assessment of the existing risk elements of RE investments in relation to the respective policies and the evaluation of their impact on the weighted average cost of capital (WACC) in Greece. A consultation procedure with key national energy stakeholders took also place, including policy makers, project developers, investors, equity providers, bankers and energy analysts in the Greek RE market, in order to provide a validation of the respective results. It has been concluded that the policy design risk represents the risk element with the greatest impact on the cost of capital and, thus, the level of RE investments’ deployment. Βased on the cost of capital valuation process followed, the WACC was estimated to reach approximately 12% for onshore wind and little lower values for solar PV projects in Greece.

In the operations management literature, the financial risk in an inventory model is usually assumed to be captured by the (constant) weighted average cost of capital (WACC) of the firm. This assumption is, at best, an approximation, since this cost depends on the risk of the cash flows, which, in turn, depends on the inventory policy. We investigate what the right cost of capital should be in an inventory model with deterministic demand. To do so, we study an inventory model with a generic inventory cost function where risk depends on the inventory decision made. Additive and multiplicative financial noise functions are included to assess the impact of these on both the cost of capital of the firm and the optimal inventory policy. We find that, in contrast to previous models, risk is not in general a monotone function of inventory. Also, a rate close to the risk-free rate, which typically deviates significantly from the WACC, should be used to value inventory-related investments when the inventory cost function is dominated by holding cost for large order quantities, even if investments are subject to other sources of financial variability.

This study tests the impact of earnings quality, investor protection, IFRS adoption and the joint effects of these on cost of capital (measured by cost of equity capital and cost of debt) in publicly listed firms in Euro zone and Asian countries. Using 199.516 firm year observations from 11 Euro zone and 8 Asian countries over the period 2000–2014, the findings confirm all research hypotheses. The results show that the cost of capital is lower in years after the adoption of IFRS as compared to the period before the adoption in Euro zone and Asian countries. A significant negative association has been found between the cost of equity capital and earnings quality in Euro zone and Asian countries. However, earnings quality is negatively correlated with cost of debt only in Euro zone countries. Similarly, the findings indicate that there is a significantly negative relationship between the cost of capital and most investor protection indexes in Euro zone and Asian countries. With regard to the joint effects of investor protection, earnings quality and IFRS adoption on the cost of capital, the results are controversial. In particular, the cost of capital has been found to be lower for firms with (a) strong investor protection and higher earnings quality, (b) higher earnings quality after the FRS adoption, and (c) strong investor protection after the IFRS adoption in Euro zone and Asian countries.

This study investigates scale economies in European real estate companies. We examine the effects of size on revenue, expense, profitability ratios and capital costs using panel data regression. We find that larger real estate companies in Europe are able to generate higher revenue per unit of company size, incur lower costs and produce higher returns. Net Operating Income ratios and return ratios increase while Selling, General and Administrative expense ratios decrease with the size of a company. However, we do not find evidence that larger companies have lower cost of debt or lower weighted average cost of capital. From our analysis, it is evident that particularly small firms can reap substantial economies of scale as they grow. However, the benefits of further growth tend to be much more modest for larger companies. Given REITs are on average larger than comparable non-REITs this may explain why REITs have lower economies of scale in expenses and revenues than Non-REIT real estate companies.

Regulators of many countries try to find the “true” WACC of Electricity, Gas, Water… activities. All their documents have in common a main confusion: they do not differentiate among expected, required, historical, and regulator allowed returns, which are 4 very different concepts. Most of the documents have several conceptual errors (they apply wrongly the CAPM and the WACC), several inconsistencies estimating parameters and multiply the WACC by the depreciated book value of assets. Another two common peculiarities of many regulators are a) their penchant for calculating averages and averages of averages, and b) their argument of doing strange calculations “because many other regulators do so.” We show how a European Regulator arrives to a “WACC before taxes of the electricity regulated activities” of 5,58%. We also show that using the same data and the same method, but criteria of other regulators for the calculation of the parameters you may justify any “WACC before taxes” in the interval 2,4% - 7,4%. After reading the mentioned documents of the regulators a question arises: Are they fiction or science fiction? We show some confusions, errors, inconsistencies and useless arguments of the documents of Regulators and propose solutions. Regulator reports (such as the one in Section 1) are very helpful to discover conceptual mistakes, valuation errors… and to think about the meaning of several concepts widely used in Corporate Finance and Financial Markets.

Myers (1974---‘M74’) derives the Cost of Capital (CC), including the corporate-tax subsidy on borrowing, for a one-period investment project. From Miles and Ezzell (1980), this CC remains valid in multiperiod projects provided that, during the project's life, debt is continuously re-aligned with ex post GPVs. In contrast, when the debt schedule is static --- i.e. set to stabilise leverage ex ante only --- no CC works outside the Modigliani and Miller (1963---‘MM63’) perpetuities scenario; one generally needs a recursive Adjusted NPV (rANPV). Real-life leverage being neither fully static nor fully dynamic, two questions arise: (i) do M74's CC and rANPV produce very different valuations in a static/multiperiod problem?, and (ii) is it useful to heuristically adopt a non-linear interpolation between the M74 and MM63 polar CCs? We find, first, that M74's CC is is (mildly) conservative but vastly less biased and more precise than MM63's. Second, two of the heuristic compromise CCs are marginally more correct than even M74, but they remain biased upwards. Remembering that M74 also applies when debt is GPV-indexed ex post, M74 seems the safer procedure. Highlights: – With a ‘static’ debt schedule set to stabilise leverage ex ante, a finite-life project’s risk cannot be constant, so no Cost of Capital (CC) can work perfectly. – When expressed as fractions of gross present value, minor-looking CC-based valuation errors largely reflect the low PV of the true tax shields rather than a precise assessment. – The Myers (1974) one-period cost of capital (CC) is mildly conservative and works very well for multiperiod NPV-ing even when debt is static. – The Miller-Modigliani CC for perpetuities, when applied in finite-life problems, is vastly overoptimistic and imprecise, especially when the CC takes into account growth. – We also propose four heuristic procedures that non-linearly interpolate between the above two CCs. The two that take into account the changing risk do succeed in beating Myers’ CC, but the gains are small and the bias is upward rather than conservative.

This paper includes the following topics: 1. The Return On Equity (ROE): What is ROE? How do we know if the ROE of a company is good or not? What should be the relationship between ROE and cost of equity(Ke)? What are the ROEs of the different industries? 2. The Return On Capital Employed (ROCE): What is ROCE? The ROCEs of different industries 3. The relationship between ROE and ROCE and the effect of debt. When the use of debt improves ROE? 4. The ROCE depends on operating margin and turnover of capital employed. Therefore, how the ROCE can be improved? 5. The ROE depends on ROCE and debt level. Therefore, how the ROE can be improved? 6. The ROE depends on net profit margin, turnover of CE and financial leverage. When financial leverage improves the ROE? 7. The ROE vs. Ke and ROCE vs. WACC. What relationship should be between ROE and Ke? What is the WACC? What relationship should be between ROCE and WACC? The ROE vs Ke and ROCE vs WACC of the different industries 8. The Economic Profit (EP) and the Economic Value Added (EVA). What is the EP and what does it indicate? What is EVA an what does it indicate? 9. How to estimate the cost of equity (Ke): the Capital Asset Pricing Model (CAPM). What is the CAPM and how to estimate Ke using it. What are the problems of the CAPM? 10. Practice questions Multiple exercises with real companies like Apple, Amazon, Microsoft, Google, Bayer, Mazda and Orange are included.

The first section (from accounting to corporate finance) answers the following questions: What is the net income? Is it what the shareholders “earn”, what the company “earns”, what someone “earns”? What does shareholders´ equity mean? Is it money? We show that net income is an arbitrary number which depends on several decisions on the accounting of expenses and revenues. We use three different definitions of cash flow: equity cash flow (ECF), free cash flow (FCF) and capital cash flow (CCF) and answer to the question: When is net income equal to the equity cash flow? The second section (shareholder value creation and shareholders return) defines, analyzes and calculates shareholder value creation. It also differentiates the expected return from the required return. The all-shareholder return is the return that all the shareholders of a company had in a period. It is equal to the hypothetical return of a unique shareholder of the company. It is also the return of a shareholder that always had a constant proportion of the shares. The all-period shareholder return is the return that a shareholder that maintained the shares for the whole period had. There are many all-period shareholder returns, depending on the actions of the shareholder during the period: fraction of dividends reinvested, fraction of shares sold when the company repurchased them, number of shares subscribed when the company increased capital… Most databases provide a specific all-period shareholder return valid for a shareholder that reinvested 100% of the dividends, did not sell any share in repurchases and did not subscribe any new share when the company increased capital. In many situations, there are substantial differences among these returns. The third section (topics and real cases on valuation) shows that It is a big mistake to use betas calculated from historical data to compute the required return to equity for seven reasons. It also shows two real valuation cases of companies. The fourth section (other finance and investing topics) shows that the Market Portfolio is NOT efficient and that it has been very easy to beat the S&P500 in 2000-2018. It also shows confusions, errors and inconsistencies of several utilities regulators when calculating WACC using CAPM.

In this short note, we present a nontechnical retrospection on the unbearable longevity of the classic WACC (Weighted Average Cost of Capital) for the Free Cash Flow (FCF) in perpetuity. Over the past two decades, researchers in finance have increased greatly our understanding of the properties of the WACC. This means that the usefulness of the classic FCF WACC has long expired. However, inexplicably, it continues to live on in textbooks and websites. The resilience of the classic FCF WACC is puzzling. We discuss some unsatisfactory reasons why the classic FCF WACC continues to thrive.

If bail-in is credible, risk premia on bank securities should decrease as funding sources junior to and alongside them in the creditor hierarchy increase. Other things equal, we find that when banks have more equity and less subordinated debt they have lower risk premia on both. When banks have more subordinated and less senior unsecured debt, senior unsecured risk premia are lower. For percentage point changes to an average balance sheet, these reductions would offset about two thirds of the higher cost of equity relative to subordinated debt and one third of the spread between subordinated and senior unsecured debt.

In this rejoinder, we note that the complaint against the classic FCF WACC is misplaced because it incorrectly identifies the real source of the problem. The fault for the discrepancies, dear colleagues, lies not in the classic formulation of the FCF WACC. The real reason for the discrepancies is more technical, subtle and nuanced. In the valuation of cash flows, the discrepancies in the results from the three methods are due to the inconsistency between the specification of the discount rate for the tax shield KTS and the corresponding expression for the return to levered equity KE. The results from all the methods will always match if the analyst uses the correct expression for KE that corresponds to the value of KTS. Cautionary note: This rejoinder draws on and summarizes ideas that were discussed in regular, polite (?) emails between the authors; however key differences remain and need to be resolved. For the moment, this rejoinder represents the best (mis)understanding and interpretations of the fundamental concepts.

Stock markets worldwide have rewarded patient investors, hence the common advice to ‘buy and hold’. Yet even with a large body of research over a prolonged period, proving this concept remains an onerous exercise for academics. We use Tobin’s Q and the dividend yield to build an equilibrium relationship for the US aggregate stock market using 119 years of data. The resulting VECM model supports practitioners making long-horizon predictions and provides powerful forecasting ability. Our work is directly applicable to UK price controls.

We advance models of valuation that incorporate personal taxes. The models are general in allowing for uneven cash flows, changes in debt levels, and changes in the costs of equity and debt. The models are mutually consistent, are consistent with the CAPM, and are consistent with the Modigliani and Miller propositions allowing personal taxes.

Spanish Abstract: El proposito de este documento es exponer los procedimientos para calcular la rentabilidad de los recursos propios de un proyecto financiado parcialmente con deuda. Muestra el calculo de las tasas variables de WACC, con y sin ahorro fiscal, para la amortizacion de la deuda, la forma de construir los tres flujos de efectivo opcionales y la aplicacion de la tasa coherente de costo de capital. Incluye ejemplos. English Abstract: The purpose of this document is to expose the procedures to calculate the profitability of the own resources of a project partially financed with debt. It shows the calculation of the variable rates of WACC, with and without tax savings, for the amortization of the debt, the way to build the three optional cash flows and the application of the coherent capital cost rate. It includes examples.

This paper discusses the influence of Corporate Governance (CG) on Cost of Capital (CoC). The study revolves on the hypothesis that optimum capital structure at minimum cost is also an agenda item of CG. Thus this study explores the influence of CG on overall cost of capital as well as at its components level. The main goal is to prove that with improvement in CG performance, leads to reduction in information asymmetry among principal and agents, enabling agency cost to decline resulting in resetting guidance for required returns for equity and debt to a lower level. Main attention was paid to nature of correlation and OLS based econometric modelling of WACC to identify the lead indicators CG should influence to create an impact. This topic was chosen on the assumption that CG has a role to play in enabling financial competitiveness for the firm to fuel its ambitious growth path. The major findings of the paper are, there exist no statistically significant differences existing among the means for CoC among the CG categories, and with rise in CG, and required return on equity and required return on debt are declining by the direction of correlation. However, in CGPI category 1, study finds required return on debt rising as a possible outcome of corporate strategies in those companies. The above findings suggest that the implications on the CoC on the whole is an outcome of the strategy implementation which is a byproduct of CG performance. Overall, study concludes that there is a reduction in CoC with rise in CG performance.

The 2015 EU Energy Union Package proposes integrating renewables into the market, just as the UK has moved away from Premium Feed-in Tariffs (FiTs) for renewable electricity supply (RES-E) to something closer to the standard FiT, which, when auctioned, demonstrated a 3% real fall in the weighted average cost of capital (WACC). The UK, which has experimented with nearly all forms of RES-E support, offers the evidence base for designing the Energy Union’s RES-E support. Innovation needs a further redesign to deliver adequate funding, best done through country contributions to an EU-wide innovation competition.

This paper examines the value of an individual's human capital and the associated return on human capital using U.S. data on male earnings and financial asset returns. We measure the size of the stock component of human capital and assess the implications for life-cycle portfolio decisions. We find that (1) the value of human capital is far below the value implied by discounting earnings at the risk-free rate and (2) the stock component of the value of human capital is smaller than the bond component at all ages and typically averages less than 35 percent of the value of human capital. Data properties that increase the stock component of the value of human capital also act to lower the stock share held in financial wealth.

Miller (2009a) opened a debate in this journal on the correct determination of weighted average costs of capital (WACC). So far Bade (2009) , Pierru (2009a) , Lobe (2009) as well as Keef, Khaled, and Roush (2012) have contributed to this debate. Even though they discuss the same, rather simple valuation problem, the dispute cannot be considered resolved. Whilst they agree that Miller erroneously assumed constant leverage ratios, the center of discussion is now placed on the question whether or not cost of capital is constant over time when leverage changes and interest paid is not tax deductible. In particular, Keef et al. (2012) demand time-invariant WACC and criticize Bade (2009) and Pierru (2009a) for allowing WACC to change over time. The aim of this paper is twofold. Firstly, we show that the arguments of Keef et al. (2012) are flawed and their criticism of Bade (2009) and Pierru (2009a) is thus unfounded. Keef et al. (2012) are wrong to ignore that not only financial risk but also operational risk can change over time. Secondly, we provide evidence that cost of capital can also be dependent on the future state of nature. So far this fact has been neglected by all contributors to this debate and becomes obvious only if state-dependent cash flow realizations, not only their expected values, are considered as well.

In a standard q-theory model, corporate investment is negatively related to the cost of capital. Empirically, we find that the weighted average cost of capital matters for corporate investment. The form of the impact depends on how the cost of equity is measured. When the capital asset pricing model (CAPM) is used, firms with a high cost of equity invest more. When the implied cost of capital is used, firms with a high cost of equity invest less. The implied cost of capital can better reflect the time-varying required return on capital. The CAPM measure reflects forces that are outside the standard model.