The Empirical Average Cost of Capital: A New Approach to Estimating the Cost of Corporate Funds

12 Pages Posted: 1 Nov 2017

See all articles by Gerard T. Olson

Gerard T. Olson

Villanova University - School of Business

Michael S. Pagano

Villanova University - Villanova School of Business

Date Written: Summer 2017

Abstract

The authors develop a new way to measure the cost of capital, called the empirical average cost of capital (or “EACC”), which is consistent with existing methods of calculating the weighted average cost of capital, but uses information from the firm’s financial statements and requires fewer and less subjective inputs. The authors’ model relies on the concept of economic profit while using data from the period 1990‐2012 on net operating profits and total capital to estimate the EACC at both the individual company and industry‐wide levels. Estimates of the EACC and rolling quarterly forecasts of future net operating profits for a single company, McDonald’s, for its related industry, and for 57 other U.S. industries are compared to five conventional “textbook” estimates of the weighted average cost of capital published by Ibbotson Associates. The authors find that the EACC yields forecasts of future net operating profit after taxes that compare favorably to those of the five published measures of the weighted average cost of capital, as well as the average and median of these measures.

Suggested Citation

Olson, Gerard T. and Pagano, Michael S., The Empirical Average Cost of Capital: A New Approach to Estimating the Cost of Corporate Funds (Summer 2017). Journal of Applied Corporate Finance, Vol. 29, Issue 3, pp. 101-110, 2017. Available at SSRN: https://ssrn.com/abstract=3061279 or http://dx.doi.org/10.1111/jacf.12254

Gerard T. Olson (Contact Author)

Villanova University - School of Business ( email )

800 Lancaster Avenue
Villanova, PA 19085-1678
United States
610-519-4377 (Phone)

Michael S. Pagano

Villanova University - Villanova School of Business ( email )

800 Lancaster Avenue
Villanova, PA 19085-1678
United States
(610) 519-4389 (Phone)

HOME PAGE: http://www90.homepage.villanova.edu/michael.pagano

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