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Cost of capital adjusted for governance risk through a multiplicative model of expected returns

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  • Rodolfo Apreda

Abstract

This paper sets forth another contribution to the long standing debate over cost of capital, firstly by introducing a multiplicative model that translates the inner structure of the weighted average cost of capital rate and, secondly, adjusting such rate for governance risk. The conventional wisdom states that the cost of capital may be figured out by means of a weighted average of debt and capital. But this is a linear approximation only, which may bring about miscalculations, whereas the multiplicative model not only takes account of that linear approximation but also the joint outcome of expected costs of debt and stock, and their proportions in the capital structure. And finally, we factor into the cost of capital expression a rate of governance risk.

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Bibliographic Info

Paper provided by Universidad del CEMA in its series CEMA Working Papers: Serie Documentos de Trabajo. with number 383.

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Length: 21 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:cem:doctra:383

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Keywords: cost of capital; governance risk; weighted average cost of capital; governance index; multiplicative model of returns;

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  1. Rodolfo Apreda, 2007. "Factoring governance risk into investors┬┤expected rates of return by means of a weighted average governance index," CEMA Working Papers: Serie Documentos de Trabajo. 356, Universidad del CEMA.
  2. Reilly, Raymond R. & Wecker, William E., 1973. "On the Weighted Average Cost of Capital," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 8(01), pages 123-126, January.
  3. Rodolfo Apreda, 2004. "Differential rates, residual information sets and transactional algebras," CEMA Working Papers: Serie Documentos de Trabajo. 256, Universidad del CEMA.
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