Cost of Capital

Dirk Schoenmaker and Willem Schramade
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Willem Schramade: Nyenrode Business University

Chapter 13 in Corporate Finance for Long-Term Value, 2023, pp 367-394 from Springer

Abstract: 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.

Keywords: Adjusted cost of capital; Asset beta; Beta; Capital asset pricing model (CAPM); Cost of capital; Cost of environmental capital rEV; Cost of financial capital rFV; Cost of integrated capital rIV; Cost of social capital rSV; Discounting; Discount rate; Factor beta; Factor portfolio; Industry beta; Integrated discount rate; Market index; Market portfolio; Return on integrated assets; Risk; Risk-free asset; Risk premium; Security market line; Social discount rate; Systematic risk; Weighted average cost of capital (WACC) (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sptchp:978-3-031-35009-2_13

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DOI: 10.1007/978-3-031-35009-2_13

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