Research Discussion Paper – RDP 8807 The Cost of Capital: Some Issues
August 1988
Abstract
The cost of capital is a potentially important determinant of business investment, yet there have been few attempts to provide an adequate measure of it. In this paper the importance of the cost of capital and weaknesses inherent in existing measures are discussed. A new series for the cost of capital is then constructed according to the methodology developed by Carmichael and Stebbing (1981).
The measure of the cost of capital developed in this paper incorporates the cost of both debt and equity finance. It also allows for changes in corporate tax rates, expected inflation and changes in sources of finance. It appears that, following large fluctuations in the cost of capital during the 1970s, the series may have again become more stable, but at a higher average level than was evident during the 1960s.