Cost of capital and asset characteristic value

Bill Y. Shen
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Bill Y. Shen: Jin Rui Capital Management Co., Shenzhen, P. R. China

International Journal of Financial Engineering (IJFE), 2021, vol. 08, issue 03, 1-17

Abstract: We propose a possible alternative to WACC as cost of capital for a business investment decision through option theory. The cost of capital in this new definition becomes forward-looking and easy to compute with traded market information as inputs. More importantly, it is a fair value- based approach and does not depend on investors’ own expectation. An important parameter “asset characteristic value” is identified and its role is further illustrated by using Merton’s capital structure model. Asset characteristic value can be calibrated by using stock price or credit spread observed from a secondary market.

Keywords: Cost of capital; asset volatility; replication; risky bond price (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1142/S2424786321500079

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