A New Model for Calculating Required Return on Investment

Yukitami Tsuji
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Yukitami Tsuji: Faculty of Business and Commerce, Keio University

No 2011-006, Keio/Kyoto Joint Global COE Discussion Paper Series from Keio/Kyoto Joint Global COE Program

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.

Pages: 33 pages
Date: 2011
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