CORPORATE CAPITAL COSTS: A PRACTITIONER'S GUIDE

Justin Pettit

Journal of Applied Corporate Finance, 1999, vol. 12, issue 1, 113-120

Abstract: Central to modern finance theory is an understanding of the cost of capital—the minimum required rate of return that is used by companies and investors for both valuation and ongoing performance measurement. This paper provides new insights into the market risk premium for U.S. equities, as well as better methods for measuring and quantifying a company's systematic risk. In so doing, it furnishes evidence that stock market investors now expect a 5% return premium over 30‐year government bonds—a decline from the 6–8% premiums suggested by the Ibbotson‐Sinquefeld data that extends from 1926 to the present. The author argues that, because of structural changes in the global economy and capital markets, only the most recent 40 or 50 years of data are relevant for estimating current risk premiums. Like the article that precedes it, this article also notes that the 30‐year Treasury bond has an increasing component of systematic risk, and the author provides a method of applying the CAPM that removes that risk component from the “risk‐free” rate and shifts it to the market risk premium.

Date: 1999
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