The Rental Cost of Sunk and Regulated Capital

John P. Small () and Henry Ergas ()

No 9908, Econometrics Working Papers from Department of Economics, University of Victoria

Abstract: Standard approaches to estimating the cost of capital are vulnerable to two errors when applied to sunk assets subject to economic regulation. First, investors in sunk assets usually have a valuable ability to delay commitment which is therefore an opportunity cost of investment. Second, economic regulation alters the distribution of returns to capital, and may do so in a way that eliminates profit potential but leaves some risk of losses. This paper studies the impact of, and the interaction between, these effects. A fundamental connection is established between the value of the real option to delay investment, the risk of losses under regulation and the rate of economic depreciation. A practical benefit of this analysis is that existing empirical methods for estimating real options can now be used to estimate the size of the "investment incentive margin" that regulated firms should be allowed.

Keywords: cost of capital; depreciation; return to capital (search for similar items in EconPapers)
JEL-codes: D21 D92 (search for similar items in EconPapers)
Pages: 25 pages
Date: 1999-06-24
New Economics Papers: this item is included in nep-fin and nep-mic
Note: ISSN 1485-6441
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.uvic.ca/socialsciences/economics/_asse ... ometrics/ewp9908.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:vic:vicewp:9908

Access Statistics for this paper

More papers in Econometrics Working Papers from Department of Economics, University of Victoria PO Box 1700, STN CSC, Victoria, BC, Canada, V8W 2Y2. Contact information at EDIRC.
Bibliographic data for series maintained by Kali Moon ().