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A Firm's Cost of Capital

Author

Listed:
  • Binying Liu

    (Department of Finance, Hong Kong University of Science and Technology, Hong Kong)

  • Iwan Meier

    (Department of Finance, HEC Montréal, Montréal, Québec H3T 2A7, Canada)

  • José Liberti

    (Kellogg School of Management, Northwestern University, Evanston, Illinois 60208)

  • Ravi Jagannathan

    (Kellogg School of Management, Northwestern University, Evanston, Illinois 60208)

Abstract

To create value, a firm must invest in projects that provide a return greater than the cost of capital. The cost of capital is not observed and its estimation requires assumptions on investors? consumption, savings, and portfolio decisions. We review the academic literature on firms? cost of financial capital and the estimation of the different components: cost of equity, cost of debt, and their relative weights. We also review various approaches to estimating the cost of capital and the assumptions justifying these approaches.

Suggested Citation

  • Binying Liu & Iwan Meier & José Liberti & Ravi Jagannathan, 2017. "A Firm's Cost of Capital," Annual Review of Financial Economics, Annual Reviews, vol. 9(1), pages 259-282, November.
    • Handle: RePEc:anr:refeco:v:9:y:2017:p:259-282
    DOI: 10.1146/annurev-financial-110716-032429
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    More about this item

    Keywords

    capital structure; cost of capital; cost of debt; cost of equity; divisional cost of capital; weighted average cost of capital;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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