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Measuring the Cost of Capital in Australia

Author

Listed:
  • Nigel Dews

    (Reserve Bank of Australia)

  • John Hawkins

    (Reserve Bank of Australia)

  • Tracey Horton

    (Reserve Bank of Australia)

Abstract

The cost of capital is the minimum rate of return that an investment project must earn in order to cover its funding costs and any tax liabilities. Australian studies on this subject have produced a wide range of estimates. This paper demonstrates that a wide range of outcomes can result from often arbitrary assumptions used in constructing measures of the cost of funds. The paper suggests that any conclusions drawn about intertemporal trends or international comparisons of the cost of capital should be treated with care. For managers, it serves as a reminder that the use of simple invariant rules-of-thumb for investment decisions may be inappropriate. In particular, changes of tax regime and inflation should be taken into account in setting ‘hurdle rates’ for investment proposals.

Suggested Citation

  • Nigel Dews & John Hawkins & Tracey Horton, 1992. "Measuring the Cost of Capital in Australia," RBA Research Discussion Papers rdp9205, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp9205
    as

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    File URL: https://www.rba.gov.au/publications/rdp/1992/pdf/rdp9205.pdf
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    References listed on IDEAS

    as
    1. Anthony J. Richards, 1991. "The Cost of Equity Capital in Australia: What Can We Learn from International Equity Returns?," RBA Research Discussion Papers rdp9107, Reserve Bank of Australia.
    2. David W.R. Gruen, 1991. "The Effect of Steady Inflation on Interest Rates and the Real Exchange Rate in a World with Free Capital Flows," RBA Research Discussion Papers rdp9101, Reserve Bank of Australia.
    3. Peter L. Swan, 1990. "Real Rates of Return in Electricity Supply: New South Wales, Tasmania and Victoria," The Economic Record, The Economic Society of Australia, vol. 66(2), pages 93-109, June.
    4. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
    5. Fama, Eugene F, 1991. "Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-1617, December.
    6. Carmichael, Jeffrey, 1978. "The Supply Price of Capital: Its Measurement and Role in Econometric Research," Australian Economic Papers, Wiley Blackwell, vol. 17(30), pages 91-102, June.
    7. Nigel Dews, 1989. "The Cost Of Capital: Some Issues," Economic Papers, The Economic Society of Australia, vol. 8(1), pages 83-96, March.
    8. Heidi Willmann, 1990. "Some Calculations on Inflation and Corporate Taxation in Australia," RBA Research Discussion Papers rdp9012, Reserve Bank of Australia.
    9. Michele Bullock & Mark Rider, 1991. "The Cross-country Relationship between Interest Rates and Inflation over Three Decades," RBA Research Discussion Papers rdp9104, Reserve Bank of Australia.
    10. Mervyn A. King & Don Fullerton, 1983. "The Taxation of Income from Capital: A Comparative Study of the U.S., U.K., Sweden, and West Germany--The Theoretical Framework--," NBER Working Papers 1058, National Bureau of Economic Research, Inc.
    11. Swan, Peter L, 1990. "Real Rates of Return in Electricity Supply: New South Wales, Tasmania and Victoria," The Economic Record, The Economic Society of Australia, vol. 66(193), pages 93-109, June.
    12. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    13. Nigel Dews, 1988. "The Cost of Capital: Some Issues," RBA Research Discussion Papers rdp8807, Reserve Bank of Australia.
    14. Warren Tease, 1990. "The Balance of Payments in the 1980s," RBA Research Discussion Papers rdp9003, Reserve Bank of Australia.
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