Cost-of-Capital in Managerial Finance: An Examination of by Dennis Schlegel

By Dennis Schlegel

This booklet examines cost-of-capital types and their program within the context of managerial finance. This comprises using hurdle charges in capital allocation judgements, in addition to goal returns in functionality administration. in addition to a evaluation of classical finance versions similar to the Capital Asset Pricing version (CAPM), different modern types and strategies to figure out the cost-of-capital of commercial devices and personal businesses are mentioned. according to a combined tools method, present cost-of-capital practices and their determinants are empirically analyzed between German companies.

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Extra resources for Cost-of-Capital in Managerial Finance: An Examination of Practices in the German Real Economy Sector

Example text

In the price system, the central company group management determines hurdle rates based on the cost-ofcapital for each business unit. In the next step, the local business unit managers identify potential projects that are able to meet the hurdle rate and report the amount of capital needed back to the headquarters. Finally, the company group raises the required amount of capital from the financial markets. That means that in the price system, no limit is set for the capital that is invested in the business units, since according to Finance theory, an unlimited amount of capital can be obtained from the financial markets if the investments yield the required return.

2006) state that in the valuation of privately held firms, often investors are involved that are insufficiently diversified. McNulty et al. (2002) argue that corporate investors do not try to minimise risk by diversification but rather through good management. The authors mentioned above focus their argumentation on the question of whether investors are really diversified in reality. However, the actual question of interest in the context of this thesis is whether investors that are not diversified should be compensated for the unsystematic risk to which they are exposed.

In the following two paragraphs, two examples of diverging risk preferences and their consequences for capital investment and financing decisions are discussed. One example of diverging risk preferences is the relevance of unsystematic risk. As pointed out in Sect. 3, diversified investors are indifferent with regard to unsystematic risk. In contrast, unsystematic risk is relevant for managers, since they are exposed to the idiosyncratic risk of the firm. As Schroeck (2002) points out, managers often invest a large fraction of their personal wealth in the company and their human capital in particular is directly linked with the performance of the company.

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