| Paper Number | KCB-WP-2025-011 |
|---|---|
| Title | Costs of Capital and InvestmentDecisions |
| Title(Other) | |
| Author | Inmoo Lee |
| Publisher | KAIST College of Business |
| Abstract | Graham (2022) shows that the Capital Asset Pricing Model (CAPM) is the most widely
used approach to estimate the cost of capital (CoC). However, in a recent article, Hommel, Landier, and Thesmar (2023) present evidence that among various discounting techniques used to predict actual market prices, an implied cost of capital (ICC) approach significantly outperforms discounting methods based on CAPM or multi-factor models. This paper studies whether firms’ investment decisions are associated with the level of the cost of capital (CoC) estimate using these two methods of estimating CoCs, ICC- and CAPM-based CoC estimates. The paper also investigates whether post-investment stock performance is associated with the levels of two CoC estimates. The results show that both ICC- and CAPM-based CoC estimates are significantly negatively associated with capital expenditure changes, but post-investment stock performance is more closely associated with ICC-based CoC estimates than with CAPM-based estimates, after controlling for known factors affecting investment decisions and performance. The results suggest that ICC-based CoC estimates can be a more desirable CoC estimate than CAPM-based estimates, which are shown to be the most widely used. |
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