Asymmetry and the Cost of Capital

Abstract

The expected cost of capital is a crucial component for most of the topics in corporate finance. Unfortunately in the presence of risky debt, it is systematically overestimated. This bias is increasing in leverage and the volatility of cash flows. We show the existence of the bias and assess its size. We finally propose a novel methodology to obtain a direct unbiased estimation of the expected return on assets. This method avoids the computational error that is obtained from the estimation of the individual components.

Keywords: Cost of Capital, Cost of Debt, Weighted Average Cost of Capital, Leverage

JEL Classification: G31, G32