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Growth Options, Beta, and the Cost of Capital

Growth Options, Beta, and the Cost of Capital We show how to decompose a firm's beta into its beta of assets‐in‐place and its beta of growth opportunities. Our empirical results demonstrate that the beta of growth opportunities is greater than the beta of assets‐in‐place for virtually all industries over all periods of time dating back to 1977. The difference has important implications for determining the cost of capital. For example, when choosing comparables to determine a project beta one should match the growth opportunities of the project with those of the comparable firm. Assuming a 6% market equity risk premium, accounting for growth opportunities alters the project cost of capital by as much as 2% to 3%. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Financial Management Wiley

Growth Options, Beta, and the Cost of Capital

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References (23)

Publisher
Wiley
Copyright
© 2007 Financial Management Association International
ISSN
0046-3892
eISSN
1755-053X
DOI
10.1111/j.1755-053X.2007.tb00084.x
Publisher site
See Article on Publisher Site

Abstract

We show how to decompose a firm's beta into its beta of assets‐in‐place and its beta of growth opportunities. Our empirical results demonstrate that the beta of growth opportunities is greater than the beta of assets‐in‐place for virtually all industries over all periods of time dating back to 1977. The difference has important implications for determining the cost of capital. For example, when choosing comparables to determine a project beta one should match the growth opportunities of the project with those of the comparable firm. Assuming a 6% market equity risk premium, accounting for growth opportunities alters the project cost of capital by as much as 2% to 3%.

Journal

Financial ManagementWiley

Published: Jul 1, 2007

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