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The cost of capital: perspectives for managers.


The woman struggled. The darkness made it difficult. She fought, took herself beyond her known physical strength. At a decisive point, a well-placed blow. A heavy rock found its mark at the animal's temple.

The struggle was over. A shuddering. A relaxed jaw released its grip. Short convulsions. The last breath.

The stalking had gone on for days. The beast lay at her side. Food. She and her child had not eaten in days. This night, the capital was human capital. Equity in the truest sense. The cost of capital in these minutes: risking the exchange of human capital for the chance to survive. She risked her personal equity capital for the chance to provide for her daughter. The risk of human capital for an exchange of future promise.

Not without many risks. Aside from tonight's struggle, an environment in which she might not survive. They had depleted the small game on which they usually fed. The fierce beast had offered the only chance for her, for her child. Tonight, the struggle in the darkness brought the woman to the edge of life. She was still at the edge. She might survive from her bleeding wounds. If not, her daughter could feed on the carcass for days and gain strength. After that, maybe her child...

Capital takes several forms: tangible, human and financial. For thousands of years people have faced important choices regarding capital. These choices affect survival and the quality of life:

* Convert current capital to meet current desires and needs. Instant gratification.

* Preserve or save capital to provide for future needs. Allowing for tomorrow.

* Invest capital in hopes of providing and possibly improving the future. The chance of changing the nature of tomorrow.

The cost of capital is a critical variable in the decision to convert, save, or invest our resources. The cost of capital is the exchange rate for making decisions.

As she rested, the woman thought about advice for her daughter. Her daughter had made it through seven periods of short days and cold nights. Instinct and other elements of human nature made her imagine that her daughter would survive, even if she died.

Although perhaps not conscious of it, that night the mother thought in terms of risk, return and opportunities. She did not have the luxury of choosing the environment, circumstances or time. Without food, the longer she delayed confronting the beast, the less her strength and chance of overpowering the fierce creature. Without food in the area for the animal, had she waited, the creature would have come for them. She made decisions in an environment fraught with risk, under the worst circumstances and lacking resources.

This battle over and uncertain of her remaining hours, she deliberated:

* Convert. Eat as much as we can in hopes of gaining strength. This also avoids the risk of attracting scavengers that will steal what we don't eat now.

* Save part of what we have. I will have my child hide some of the meat with hopes it will be safe and available for our use. The cave is cool. We can cover the meat with rocks. Saving is not without risk. The meat might spoil and loose its value or other predators may come before I regain enough strength to flee to the safety of our cave.

* Invest some of the flesh. We can travel away from our area. We could put pieces out as bait and hope to lure small game that we can catch and eat. There is risk that we lose this bait, capital. We may not attract or catch anything. We may attract other violent creatures that will feed on us.

The opportunity set

The mother recognized the importance of opportunities. She knew the importance of capital in the pursuit of opportunities. In an intuitive way, she knew choice involved expected returns and risks. Good decisions require an attractive return in exchange for placing capital at risk. The woman reflected on the circumstances.

I may not survive my wounds. Using some of the flesh as bait offers promise for my child. At her age, size, she could only hope to catch and kill small animals. If I perish, my daughter will be safer in an area with small game. She must move to an area with new opportunities. I must tell my daughter what to do. If I cannot go with her, she must walk in the direction of the rising sun. She must take some meat as bait and walk until she finds water and small animals. She must take care to not waste the bait. She must think of what she might catch before she sets the bait. She must not put all the meat in one spot. Just enough to attract a small animal. She must not put out more meat than she can watch or manage.

Sunk costs

The woman thought about past mistakes. She should have given up the comfort of the good cave. She should have moved before tonight. She should have ... Past opportunities are not relevant. She can't change the past. She thought about the present. The fight with this animal was over. The bites and gashes from tonight's battle were sunk costs. She faced decisions.

Looking ahead

The mother realized these thoughts were helpful only in terms of the learning experience. She could not change the past or bring past opportunities to the present. She must think and act by looking ahead. She faced incremental decisions in the environment of the moment - for now and for the future.

The search for value focuses on choices for today and tomorrow. The task requires finding alternatives and making choices. The cost of capital for these choices is not historical but a forward-looking incremental cost.

The woman focused on what to do now and in the future. These are incremental rather than historical decisions. The opportunity cost of human, tangible and financial capital is incremental. The cost of capital accounts for the opportunities and risks in the current and future environment.

The cost of capital captures how people currently value expectations about today and tomorrow. The proper estimation of the COC hinges on determining how market participants value risk-return opportunities given existing alternatives.


We use different terms to characterize most choices. Usually, we think of cost of capital in terms of financial and tangible capital[1]. Capital takes many forms. For each form, the cost of capital is the exchange rate for choice. Shortly we will focus on the cost of financial capital and recognize that the COC is a function of several important variables.

Since that night thousands of years ago, the circumstances of choice have changed. The nature and difficulties of these choices remain. Leaders and managers face the task of using, saving or investing the capital of shareholders. The right decisions result in value creation for shareholders, employees and society. The wrong decisions destroy value and result in a loss of some or all of our capital.

The paper describes the meaning of the cost of capital and relates its use to making decisions that add value to a company and society. It explains the meaning of true economic value added (TEVA). Capital and the employment of capital have an especially crucial role in emerging and transition economies. This role prompts inclusion of a section focusing on the vital role of cost of capital in these economies.

The paper provides conceptual background. Then it characterizes the cost of capital in the context of business decisions. Implications, guidelines, special issues for transition economies and a summary follow.


The bedrock of theory

People have studied and written about the cost of capital at least since biblical times. Modern theories and the expositions of concepts stem from the works of Franco Modigliani and Merton Miller (1958). Their seminal work on capital structure and cost of capital is the foundation of modern corporate finance. Many experts assert that their work represents the most significant contribution to the field of finance. The Nobel committee awarded Modigliani and Miller the 1985 Nobel Prize in Economics for their pioneering work.

Extensions of theory

Economic and financial scholars have furthered Modigliani and Miller's work and enhanced our understanding of the cost of capital and related issues. A sampling of important contributors includes: Miller (1977) who introduced the concept of taxation into Modigliani and Miller's model; DeAngelo and Masulis (1980) who analyse the effect of tax shields due to interest payments on debt; Hamada (1969) and Rubinstein (1973) who introduce risk into the model; and Smith and Stulz (1985) who investigate the implications of the maturity structure of debt.

Applications of theory

Many researchers study the practical applications of the cost of capital in modern financial markets. A sampling includes Eugene Brigham (e.g. see Brigham et al. (1985)) who has distinguished himself by understanding the theory as well as the practical issues related to cost of capital. Conine and Tamarking (1985), Harris et al. (1989) and Krueger and Linke (1984) offer guidance on the use of costs of capital for different divisions of a firm. Others, such as Siegel (1985), provide guidance on estimating the costs of capital.

Conceptual relationships

Overview of the capital cycle

We focus on financial capital and economic events. Economic events represent the presence of cash, the flow of cash and the opportunities to realize cash[2]. For example, selling an asset, paying taxes and realizing the net after tax cash flow of the sale represents an economic opportunity.

Figure 1 depicts a simplified cash cycle. Previous papers in this series provided detail on the cycle (see Byers et al., 1997).

The cycle depicts the conversion of cash into the production process, then to goods and services and finally back to cash in the form of sales and receivables. The decision to change capital from one form to another entails evaluating expected returns and risks. For example, capital in the production process is at greater risk than holding cash. The cost of capital is the minimum rate of return, given the risk, for investing and flowing capital through the business cycle.

The importance of alternative opportunities

Opportunities allow for choice and dictate decisions. The decision to invest capital in and flow capital through the cycle hinges on opportunities to employ the capital elsewhere. The opportunity cost of capital (OCC) represents the opportunity to earn an expected rate of return elsewhere at the same level of risk.

Investments in this business cycle are rational if they generate economic returns greater than the cost of capital and higher than that available in alternative opportunities of equal risk. The indifference point between investing in this cycle or using our money elsewhere is the minimum exchange rate of capital or the cost of capital (COC). The COC is the hurdle rate we apply to decisions such as investing in or disinvesting from the economic cycle. Generating returns greater than COC creates value.

The cycle and share price

The cost of capital allows us to make decisions intent on preserving and enhancing value. Earning a return in excess of the cost of capital satisfies us. Share price increases. Success at generating value for shareholders has other affects such as attracting new, additional capital at a lower cost.

An economic return less than the cost of capital disappoints people. Share price declines. Earning a positive return less than the inflation rate or negative returns destroys capital. The destruction of value and capital makes the market change its perceptions about the merits of allowing us to keep capital or attract incremental capital. Consequently, a poor record of creating value adversely affects the availability and cost of capital.

Sources of capital: the basic notions

In some tax environments interest payments on debt is tax deductible. This lowers the cost of debt and prompts the use of a combination of debt and equity. The capital structure decision focuses on determining the proportions of total capital a company should obtain from debt and equity. The next paper will illuminate capital structure and its influence on company value.

Equity represents ownership

Equity capital takes two forms: first, new equity obtained from the issuance of stock and, second, economic profits earned and retained in the company. Some points about these sources of equity:

* The issuance of new common stock. Issuing new stock includes costs such as transactions costs, legal fees and the underpricing of the new stock to take account of dilution from more shares and to attract buyers for the stock.

* Retained economic profits. Net economic returns generated from operating the business and retained in the company rather than paid to shareholders represent equity. This capital is after tax. In many tax environments, if the company paid these retained earnings to the shareholders in the form of dividends, shareholders would pay a second tax on this money.

Retaining funds that the firm earns avoids the various costs associated with issuing new equity. In addition, it avoids asking investors for capital on which investors have paid a second tax[3]. Because issuance costs and double taxation is avoided on internally generated capital, these funds will have a lower cost compared to a new equity issue. Estimating the cost of equity capital is a' non-trivial task. This paper focuses on perspectives for the manager. Hence, we delay attention to these details to another occasion.

Debt entails promise and obligation

Debt may have many characteristics. For simplicity, our debt represents capital provided by creditors in return for the promise to make interest payments and to repay the principle[4].

Creditors have a claim on cash flows ahead of equity holders. The company dedicates cash flows from any source to meeting requirements of the creditors. In essence, creditors have first claim on any cash flows. Recognize that if creditors take the most certain dollars out of a stream, the risk of the remaining cash flows must increase. Phrased another way, the quality of the cash flows left over for equity holders is lower if creditors take the "best" or most certain cash flows.

In summary, equity holders have claim only on the residual cash flows or net economic returns. The result: creditors have less risk than equity holders; the cost of equity is greater than the cost of debt since stockholders bear greater risk[5].

The weighted cost of capital (WCOC)

Because each provider of capital faces a different set of risk factors, the rate that they demand for the use of their capital will vary depending on the provider. Most companies obtain capital from both debt and equity. The weighted cost of capital (WCOC) reflects the costs of getting part of total capital from equity and the remainder from debt or other sources[6].

Figure 2 depicts the inputs into the weighted costs of capital. Capital from the various sources provide the pool of capital available for use by the firm.

Illustration of calculating the WCOC

Assume a company plans to obtain 50 per cent of its future capital from internally generated funds or economic retained earnings, 20 per cent from issuance of new stock and 30 per cent from debt. Given these choices and market perceptions about the company, the after tax cost of equity from new stock is 19 per cent and 17 per cent for internally generated equity. The after tax cost of debt is 8 per cent.

WCOC = (0.50)(17%) + (0.25)(19%) + (0.30)(8%)

= 8.5% + 4.75% + 2.4% = 15.65%

Estimating component costs

This paper defers details of estimating costs of the individual components of cost of capital. For managerial perspective, the following are important:

* Proper estimation of the WCOC stems from observation of how the market values a company and other risky opportunities. Hence, the WCOC reflects many factors including the market's perceptions of the risk of the company and the company's intended method of financing.

* Properly estimated, the WCOC reflects the market's exceptions of other opportunities to invest or consume, expected inflation, political risk, behavioural factors and any variables that influence how people value risky assets.

* The capital structure decision focuses on deciding how to raise capital from equity and debt. The capital structure choice and the interplay of other factors determine the costs of equity and debt. A discussion of these issues awaits the next paper.

Uncertainty exists in the estimates of the component costs of the WCOC[7]. That prompts us to round the 15.65 per cent to 16 per cent.

Company WCOC and risk

This 16 per cent WCOC is the appropriate hurdle rate, cost of capital, or required rate of return to evaluate projects that have a risk level similar to the average risk of projects the company normally undertakes.

Project risk and COC

The risk of a project may differ from the risk complexion of the company that is reflected in the company's WCOC. Required returns vary with risk. The company must determine the appropriate cost of capital demanded by the market for projects of similar risk.

Creating value requires the company to earn more than this rate. Hence, the appropriate cost of capital for projects reflects the rates demanded by the market for such risky opportunities. The company's WCOC represents a reference point. The manager must set the hurdle rate higher (lower) for projects of greater (less) risk than reflected in the WCOC.

Incremental WCOC

Properly determined, the WCOC captures the cost of incremental or new capital. Incremental economic decisions must exceed or equal the incremental cost of capital hurdle. Historical costs of capital are inappropriate[8]. To illustrate, think about buying a house. The current interest rate on a mortgage and the cost of the equity that the buyer invests in the house are relevant - not historical interest rates or equity returns - in the decision to buy the house.

Pool of capital concept

If a company undertakes a project, the company has exposure to the expected benefits and liabilities of the project. In a real sense, the company is "on the hook." The company will reap the benefits or suffer the consequences of the project[9]. No insulation or barrier exists between the project and the company. Under these circumstances, one should think in terms of a pool of capital having weighted costs - and not tie a project to a particular source of capital.

The company obtains capital from different sources. Consider this money in the pool of capital. In decision making, one should not view capital with regard to the particular source of the capital. The WCOC reflects the decision and actions of how the company will raise capital now and in the future. To illustrate why one does not tie a particular project to a particular source of capital, we turn to an example[9].

Example for pool of capital

Suppose two people in a company seek funds and approval for two different capital projects. Assume both projects have the same risk, measured as 1.7R. We intentionally do not define the units of risk to avoid a debate about how to measure risk which is not germane to the essential point.

Sherry arrives at the treasurer's office and requests $12 million for her division's project. Sherry is well prepared for the questions from Mr I.R. Slow, the treasurer. Table I shows the responses that the treasurer noted from Sherry.

Mr Slow glanced in the pool of capital and noticed $12.3 million was available. He also knows the WCOC = 16 per cent. He mentally notes:

* We have enough money in the pool.

* The project's risk is equal to the company's overall risk of 1.7R, so we should use the hurdle rate of 16 per cent.

* The internal rate of return (IROR) or the project's expected return over its economic life is 18.5 per cent. That is greater than the 16 per cent. The project is good.

* The net present value is positive. The project is good by the NPV criteria.
Table I
Project A

               Capital     Risk of    Internal rate     Net present
Project        required    project      of return          value

A: Sherry    $12 million    1.4R          18.5%         $2.4 million

Mr Slow approves the project and obligates the money to Sherry's project A. As Sherry leaves, Richard enters Mr Slow's office. He never would have stopped for coffee if he had known Sherry was coming in to get capital.

Mr Slow asks Richard the same questions. Richard is equally well prepared. There are a few miracles. Note that Richard's project B has the exact same summary information as project A (see Table II).

Mr Slow is pleased. This meeting will be short. He is eager to approve the project. Then Mr Slow remembers. The pool of capital has only $0.3 million left. Since the company has already borrowed and used its debt capacity, he will have to issue new common stock. He recalls the cost of money from new equity is 20 per cent[10]. Richard's project B has an IROR of only 18.5 per cent, less than the 20 per cent. Erroneously, Mr Slow says, no - he will not approve funds for project B.

Mr Slow has erred by relating a particular source of capital at a moment in time to a particular project. We can quickly reveal his error. Pretend Sherry had stopped for coffee. Richard would have entered the office first. Slow would have approved project B. Clearly, the order in which Sherry and Richard enter the office does not determine the economic worth of a project. Both projects are good. Slow should approve both.

Slow should raise capital in a fashion consistent with corporate strategy: 50 per cent from retained earnings, 20 per cent from the issuance of new stock and 30 per cent from debt. Recognizing that the firm raises capital from three different sources and the weighted cost of capital is 16 per cent, Slow should have approved both projects. At the current time, the company is in the process of raising new equity capital at a cost of 19 per cent. Unfortunately, Mr Slow thought that by applying the 19 per cent rate to Richard's project he was using the relevant cost of capital for the firm. The fact that new equity is the next source of capital for the pool is irrelevant in the acceptance decision for projects A and B. The WCOC is the appropriate measure.
Table II
Projects A and B

               Capital     Risk of    Internal rate     Net present
Project        required    project      of return           value

A: Sherry    $12 million     1.7R         18.5%         $2.4 million
B: Richard   $12 million     1.7R         18.5%         $2.4 million

True economic value added (TEVA)

True economic value added or TEVA is subtly different from other popular measures. Two elements are critical in determining the TEVA: all economic events that will occur as a result of a course of action and the appropriate cost of capital to evaluate those events.

TEVA incorporates all economic events and economic opportunities. TEVA captures all expected after tax cash flows that result from pursuing a particular course of action rather than just the events of a period. In addition, properly executed, a TEVA analysis embodies the opportunity cost of assets rather than the accounting or book value of assets.

In TEVA analysis, one relates the economic returns to the economic value of capital. The cost of capital is the relevant relational variable. We will illustrate with a simple project. This procedure will illustrate invested capital, cost of capital, yearly realized return on capital, yearly increments to value and the total value in today's dollars of the project.


You invest $100 in company CBA for a four-year period. With respect to your investment, your project has a four-year life. You could have consumed the capital on a nice dinner out, saved it in an insured bank account or invested it in another risky opportunity, Fortunately for CBA Company, you bought into their project. You realize you could lose your $100 of capital. However, you expect that the managers will preserve your capital and earn an economic return.

You have an opportunity to put your $100 into another equally risky investment that pays an expected return of 15 per cent. The 15 per cent is the opportunity cost of capital, the minimum expected rate of return to prompt your investment, the required rate of return or the hurdle rate. People use these and other expressions to characterize the opportunity to earn a return elsewhere with similar risk exposure to their capital. For simplicity, we assume your OCC does not change during the six-year period. This is not realistic. It simplifies the numbers but does not detract from the true message.

We are standing at time zero or the present and want to eventually determine the present value of the project. Tables III-VI and the explanations below outline the concept of adding true economic value:

* Column one is the time period.

* Column two is the capital you have at risk during each year of the investment. We assume that any money the investment earned during each year remains invested.

* Column three is the realized rate of return (ROR) earned on your investment during the year.

* Column four is the product of the per cent ROR and your investment and represents the dollar amount invested at year end.

* Column five shows your cost of capital (COC) in percentage form and the expression to calculate the dollars the project must earn just to preserve value.

* Column six provides the year-end true economic value added during the year from the investment. Notice the dollar amount is the difference between the dollar amount realized and shown in column three and the dollar amount required to just preserve value, given in column five.

Year 1

The realized rate of return for the project was 15 per cent during the first year. However, because your cost of capital is 15 per cent, earning $15 just maintains value. The net economic gain for year 1 is $0.00. The benefits of the project (15 per cent) exactly equal the cost of having the capital invested in the project (see Table III).

Year 2

Since the investment earned 15 per cent in the first year, the investment this year is the original $100 plus the first year's earnings of $15 at risk. In year 2, the investment again realized a return of 15 per cent, the same as the cost of capital. There is again no creation of economic value (see Table IV).

Year 3

The total capital at risk at the start of year 3 is $132.25. For year 3, the rate of return increased to 18 per cent. Since the realized rate of return is greater than your cost of capital, you create true economic value equal to (18 per cent - 15 per cent) x (117.25) = $3.97 (see Table V).





Year 4

In year 4, the rate of return is 17 per cent. Again, a realized rate of return greater than the cost of capital results in an increment to true economic value of $3.12.

Determining the total value of the project in today or present value dollars requires that we adjust increments of value in column six for years 3 and 4 back to the present. We use the present value technique we illustrated in the last paper in this series to bring the dollars back to the present. Discounting each of the individual TEVAs at the cost of capital of 15 per cent gives total economic value added of $4.39. The TEVA of $4.39 reflects today's value of all future investment returns in excess of the cost of capital (see Table VI).

Implications and guidelines

The following guidelines are useful in the pursuit of value creation:

* Analyse decisions on an economic rather than accounting basis.

* Think of the cost of capital as another economic cost of undertaking a course of action.

* Since actions transform capital into different forms and/or expose that capital to different risks, use the cost of capital as an exchange rate in evaluating decisions.

* Determine and use the cost of capital on an incremental basis.

* The pool of capital represents funds the company expects to have available at the weighted cost of capital (WCOC).

* The WCOC is the appropriate cost of capital for evaluating projects that have risk similar to the projects that the company has already undertaken.

* If all risks and expected returns of the project have been properly evaluated, consider the project independent of the current particular source of capital.

Emerging and transition economies

Important factors influence the cost of capital and its use in transition and emerging economies[11]. These economies have the following characteristics:

* They have limited capital.

* The cost of capital is high, to a great extent because of political risks, inexperience in transforming capital into goods and services and the lack of experience in gainfully employing capital.

* The high cost of capital limits investments and hence inhibits the generation of capital. Limited capital generation exacerbates the shortage of capital and has an adverse feedback effect on capital costs.

* The risk of the environment has an adverse effect on the retention of capital within the economy. Those who have or generate capital export it to more favourable risk-return opportunities.

* The shortage of capital in these economies results in unusually adverse effects if the firm fails to earn the cost of capital. These ominous outcomes extend beyond the firm to the economy.


Capital takes several forms. The cost of capital is the exchange rate for transforming capital into different forms and/or exposing that capital to different risks. Earning a rate of return in excess of the cost of capital results in the generation of value with other favourable effects such as the generation of new capital for the firm and economy. Failure to earn the COC eradicates value for the firm and for the economy.

The weighted cost of capital WCOC for a firm reflects the incremental cost of capital to the company given its plans on raising capital and the markets perceptions of the prospects for the company and, alternative opportunities for the use of capital in the market. The WCOC is the opportunity cost of capital or hurdle rate the company should use in evaluating the attractiveness of projects having risk similar to that embedded in estimates of the WCOC. Evaluating projects of greater or lesser risk requires one to adopt a hurdle rate adjusted for the difference in risk. This adjustment properly takes account of the market's perceptions of the required rates of return for opportunities of such risk.

Economic decisions focus on economic events. Managers must ensure analysis takes account of all expected cash flows associated with a particular course of action. The proper evaluation of these cash flows will employ the appropriate cost of capital. Total economic value added represents one approach to determine the economic worth of pursuing an alternative.

In practice, managers should exert care to ensure that incremental decisions rest on incremental economic events. One must be careful to avoid the use of sunk costs, historical costs, accounting book value, embedded costs and historical opportunities in the analysis. Efficacy in economic analysis and decision making hinges on examining opportunities in the context of expected returns and risk. The COC is the minimum acceptable rate of return that one should demand before exposing capital to risk.


1 We do face and make decisions in the context of human capital in many situations such as medicine, facing a criminal element, and in war.

2 An earlier paper in the series reviewed the difference between economic and accounting events. See Groth and Byers (1996).

3 To illustrate: A company pays a cash dividend to an investor of $1.00 out of after-tax cash flows. If the investor has a 30% marginal personal tax rate, the investor only has $0.70 to consume or invest elsewhere.

4 The incredible variety of financial instruments is of professional interest to the business leader and manager. A future paper will identify and sketch the characteristics of different financial instruments. The paper also provides guidelines useful to the manager in assessing critical issues related to the valuation and choice of financial instruments in terms of financing a company or in terms of investments.

5 In the next paper we will see that conceptually under certain circumstances the incremental cost of debt and equity is the same at the margin.

6 A company may obtain capital from preferred stock as well as other sources. To simplify the discussion, we focus on just debt and equity sources.

7 Estimation of the cost of equity is a non-trivial task. The focus of this paper causes us to direct readers to textbooks that provide a discussion of estimation methods of component costs.

8 This perspective is appropriate for economic decisions. Special considerations are appropriate for regulated industries in some environments. Regulators sometimes do incorporate historical capital costs in various schemes that ultimately affect the rates allowed and hence, the cash flows of a company. These instances require special consideration to ensure one properly evaluates incremental economic decisions.

9 Project financing is very different from company financing of a project. In pure project financing the providers of capital will only receive returns from the project itself. A future paper will address important issues related to project financing.

10 The next paper will explain "good" and "bad" debt capacity. For now assume "good" capacity represents the maximum amount a company should borrow.

11 Groth and Anderson (1996) address details on these and related issues. This working paper is available from the authors.


Brigham, E.F., Shome, D.K. and Vinson, S.R. (1985), "The risk premium approach to measuring a utility's cost of equity", Financial Management, Vol. 14 No. 1, pp. 33-45.

Byers, S.S., Groth, J.C. and Wiley, M.K. (1997), "The critical operating cycle", Management Decision, Vol. 35 No. 1, pp. 14-22.

Conine, T.E. and Tamarking, M. (1985), "Divisional cost of capital estimation: adjusting for leverage", Financial Management, Vol. 14 No. 1, pp. 54-8.

DeAngelo, H. and Masulis, R. (1980), "Optimal capital structure under corporate and personal taxation", Journal of Financial Economics, March, pp. 3-30.

Groth, J.C. and Anderson, R.C. (1996), "Marketing and value creation: critical perspectives for transition economics", working paper, Texas A & M University, TX.

Groth, J.C. and Byers, S.S. (1996), "Creating value: economics and accounting - perspectives for managers", Management Decision, Vol. 34 No. 10, pp. 56-64.

Hamada, R.S. (1969), "Portfolio analysis, market equilibrium, and corporation finance", Journal of Finance, March, pp. 13-31.

Harris, R.S., O'Brien, T.J. and Wakeman, D. (1989), "Divisional cost-of-capital estimation for multi-industry firms", Financial Management, Vol. 18 No. 2, pp. 74-84.

Krueger, M.K. and Linke, C.M. (1984), "A spanning approach for estimating divisional cost of capital", Financial Management, Vol. 13 No. 3, pp. 15-31.

Miller, M.H. (1977), "Debt and taxes", Journal of Finance, May, pp. 261-75.

Modigliani, F. and Miller, M.H. (1958), "The cost of capital, corporation finance, and the theory of investment", American Economic Review, June, pp. 261-97.

Rubinstein, M.E. (1973), "A mean-variance synthesis of corporate financial theory", Journal of Finance, March, pp. 167-81.

Siegel, J.J. (1985), "The application of the DCF methodology for determining the cost of equity capital", Financial Management, Vol. 14 No. 1, pp. 46-53.

Smith, C. and Stulz, R. (1985), "The determinants of a firm's hedging policies", Journal of Financial and Quantitative Analysis, December, pp. 391-406.

Application questions

1 The authors tell a story to illustrate that capital takes forms other than just financial. How else can the cost of capital framework be used in personal and organizational life?

2 How would you differentiate, as the authors advise, between an accounting perspective and an economic one?
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Author:Groth, John C.; Anderson, Ronald C.
Publication:Management Decision
Date:May 1, 1997
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