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For the Pure-Play Firm: Find the True Cost of Capital for Your Capital Projects

Tom Schmal ()

MPRA Paper from University Library of Munich, Germany

Abstract: Approving capital projects can be one of management’s toughest calls. One reason is while a project's return can be presented quantitatively, eg., IRR, its risks have no comparable metric. The author addresses the problem by showing how to use a Monte Carlo simulation to measure your project’s risk and how to use that risk to find its true, risk-adjusted, cost of capital. In this system, risk is determined by variation in free cash flow. Since every project in your company’s pipeline will have a forecasted free cash flow, every project, including those with financial leverage, can be evaluated using the same economic yardstick. Other benefits include better value projects, better presentation and accurate discount rates for NPV.

Keywords: cost of capital; IRR; NPV; cash flow; Monte Carlo; capital project economics; risk-adjusted return; M-P5; variability; pure play; leverage; hurdle rate. (search for similar items in EconPapers)
JEL-codes: D81 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-pr~ and nep-ppm
Date: 2015-11-26
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https://mpra.ub.uni-muenchen.de/71100/1/MPRA_paper_68092.pdf original version (application/pdf)

Related works:
Working Paper: Improve the Economics of your Capital Project by Finding its True Cost of Capital (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:71100

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