Investment and the Weighted Average Cost of Capital

51 Pages Posted: 4 Mar 2012 Last revised: 20 Jul 2015

Murray Z. Frank

University of Minnesota

Tao Shen

Tsinghua University

Date Written: April 24, 2015

Abstract

In a standard q-theory model, corporate investment is negatively related to the cost of capital. Empirically, we find that the weighted average cost of capital matters for corporate investment. The form of the impact depends on how the cost of equity is measured. When the capital asset pricing model is used, firms with a high cost of equity invest more. When the implied cost of capital is used, firms with a high cost of equity invest less. The implied cost of capital may better reflect the time-varying required return on capital. The CAPM measure reflects forces that are outside the standard model.

Keywords: Weighted average cost of capital, investment, CAPM, implied cost of capital

JEL Classification: G31; G32

Suggested Citation

Frank, Murray Z. and Shen, Tao, Investment and the Weighted Average Cost of Capital (April 24, 2015). Available at SSRN: https://ssrn.com/abstract=2014367 or http://dx.doi.org/10.2139/ssrn.2014367

Murray Z. Frank (Contact Author)

University of Minnesota ( email )

Carlson School of Management
321 19th Avenue South
Minneapolis, MN 55455
United States
612-625-5678 (Phone)

Tao Shen

Tsinghua University ( email )

Department of Finance
School of Economics and Management
China

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