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A New Model for Calculating Required Return on Investment

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  • Yukitami Tsuji

    (Faculty of Business and Commerce, Keio University)

Abstract

It is widely accepted that the required return on investment is regarded as the weighted average cost of capital. The method for deciding whether an investment should be executed relies on the weighted average cost of capital; for example, NPV or IRR is presented in many textbooks as fundamental consideration. This method is theoretically appropriate in only a few models, such as the Modigliani-Miller(1963) hypothesis. Because other factors, such as financial distress costs and agency costs, are now generally recognized and applied, the method must be modified. How do we decide whether to implement an investment? This study provides an alternative to the weighted average cost of capital. The new method endogenously calculates the required return from a model that extends a bankruptcy cost model to consider agency costs.

Suggested Citation

  • Yukitami Tsuji, 2011. "A New Model for Calculating Required Return on Investment," Keio/Kyoto Joint Global COE Discussion Paper Series 2011-006, Keio/Kyoto Joint Global COE Program.
    • Handle: RePEc:kei:dpaper:2011-006
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    References listed on IDEAS

    as
    1. Hayne E. Leland, 1998. "Agency Costs, Risk Management, and Capital Structure," Journal of Finance, American Finance Association, vol. 53(4), pages 1213-1243, August.
    2. Erwan Morellec, 2004. "Can Managerial Discretion Explain Observed Leverage Ratios?," The Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 257-294.
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