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Cost of Capital

In: Corporate Finance for Long-Term Value

Author

Listed:
  • Dirk Schoenmaker

    (Erasmus University Rotterdam)

  • Willem Schramade

    (Nyenrode Business University)

Abstract

A company’s value is determined not just by its expected cash flows, but also by its cost of capital, which we explore in this chapter. We start with the cost of financial capital rFV, which is the required minimum return on financial capital that is used in investment decisions. Subsequently, we consider the impact of S (social) and E (environmental) risks on the cost of financial capital. That is, to what extent do companies incur additional (or reduced) financial risk from their S and E exposures? We then address the cost of social capital rSV and the cost of environmental capital rEV in their own right. These tend to be much lower than a company’s cost of financial capital. The flip side is that the present value of assets and liabilities on E and S tends to be quite high, as discounting with a low discount rate reduces the present value of underlying value flows in a limited way. Finally, we put rFV, rSV, and rEV together to obtain the cost of integrated capital, rIV, which is the return on integrated assets that is demanded by the company’s stakeholders on aggregate. Interestingly, rIV gives an indication of the overall risk of the company, which can differ substantially from the risk picture that emerges from a purely financial perspective, even if that financial perspective is taken on an ESG integrated basis.

Suggested Citation

  • Dirk Schoenmaker & Willem Schramade, 2023. "Cost of Capital," Springer Texts in Business and Economics, in: Corporate Finance for Long-Term Value, chapter 13, pages 367-394, Springer.
    • Handle: RePEc:spr:sptchp:978-3-031-35009-2_13
    DOI: 10.1007/978-3-031-35009-2_13
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