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Risk Structure Analysis for Cost of Capital: A Demonstrative Study using Financial Indices

Risk Structure Analysis for Cost of Capital: A Demonstrative Study using Financial Indices Economic value added (EVA) is introduced on two levels: as index for evaluation of corporation and as index for evaluation of business unit. In the latter case, application of one and the same cost of capital to all business units of a business corporation may be possible, but it is a fundamental policy for EVA to apply different cost of capital to business units with different risks. Estimate of cost of capital of business units is a problem to be resolved. The author, focusing on the question of the estimate of cost of capital of business units, has conducted a demonstrative study on risk structure of cost of capital estimates by using financial indices of Japanese manufacturers (37 automotive industries, 141 electrical and electronic machinery industries, 63 food processing industries, 98 chemical industries, 125 general machinery industries) for a period of 5 years from 1995 to 1999. The author presumes that ॆ is explained by a regression formula ॆ = B 0 + ऱB i Y i + ॅ (Y i : financial indices) and selects 40 explanatory variables from financial statements as risk components. Using their financial indices, the author concludes through a series statistical analyses that there is a good likelihood of estimating cost of capital for Japanese industries and is convinced that it will lead to more reliable and practical results by assigning averages and variances to 40 primary financial indices for a period of 3 to 5 years selected in this demonstrative study. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asian Journal on Quality Emerald Publishing

Risk Structure Analysis for Cost of Capital: A Demonstrative Study using Financial Indices

Asian Journal on Quality , Volume 7 (3): 14 – Dec 18, 2006

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Publisher
Emerald Publishing
Copyright
Copyright © 2006 Emerald Group Publishing Limited. All rights reserved.
ISSN
1598-2688
DOI
10.1108/15982688200600023
Publisher site
See Article on Publisher Site

Abstract

Economic value added (EVA) is introduced on two levels: as index for evaluation of corporation and as index for evaluation of business unit. In the latter case, application of one and the same cost of capital to all business units of a business corporation may be possible, but it is a fundamental policy for EVA to apply different cost of capital to business units with different risks. Estimate of cost of capital of business units is a problem to be resolved. The author, focusing on the question of the estimate of cost of capital of business units, has conducted a demonstrative study on risk structure of cost of capital estimates by using financial indices of Japanese manufacturers (37 automotive industries, 141 electrical and electronic machinery industries, 63 food processing industries, 98 chemical industries, 125 general machinery industries) for a period of 5 years from 1995 to 1999. The author presumes that ॆ is explained by a regression formula ॆ = B 0 + ऱB i Y i + ॅ (Y i : financial indices) and selects 40 explanatory variables from financial statements as risk components. Using their financial indices, the author concludes through a series statistical analyses that there is a good likelihood of estimating cost of capital for Japanese industries and is convinced that it will lead to more reliable and practical results by assigning averages and variances to 40 primary financial indices for a period of 3 to 5 years selected in this demonstrative study.

Journal

Asian Journal on QualityEmerald Publishing

Published: Dec 18, 2006

Keywords: Economic value added (EVA); Business unit; Cost of capital; ॆ value; Financial indices; Risk structure analysis

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