Implications of Inconsistency in Adjusting the Cost of Capital for Leverage. A Note

10 Pages Posted: 2 Jan 2019

See all articles by Rauf Ibragimov

Rauf Ibragimov

Russian Presidential Academy of National Economy and Public Administration

Date Written: 2018

Abstract

A common procedure for determining the cost of capital for capital investment decisions involves adjusting an unlevered beta for the risk of financial leverage. This note demonstrates that a widespread practice of levering the beta coefficients using the formula of Hamada implies a possibility of significant errors in the cost of capital estimates that may eventually yield implausible valuation results. To avoid potential distortions, the formula of Hamada should be replaced with a consistent expression relating the beta coefficients of unlevered equity, levered equity and debt.

Keywords: cost of capital, levered beta, valuation, capital investment analysis

JEL Classification: G30, G31, G32

Suggested Citation

Ibragimov, Rauf, Implications of Inconsistency in Adjusting the Cost of Capital for Leverage. A Note (2018). Available at SSRN: https://ssrn.com/abstract=3298042 or http://dx.doi.org/10.2139/ssrn.3298042

Rauf Ibragimov (Contact Author)

Russian Presidential Academy of National Economy and Public Administration ( email )

Vernadskogo Avenue,82
Moscow, Moscow region 119571
Russia
007 495 4347103 (Phone)
007 495 4349027 (Fax)

HOME PAGE: http://www.ranepa.ru/eng/

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