Every aspect of a risky business affects its cost of capital
Published Wed 22 Apr
This paper reveals some surprising implications of the capital asset pricing model (CAPM) which accord with common sense but not necessarily with finance textbooks. The key finding is that the cost of capital or discount rate applying to a given firm or business venture is affected by every aspect of that business, not just by its market risks or uncertainties. For example, if the firm changes its CEO, it will invariably attract a new cost of capital, either higher or lower than previously. Although this finding might seem to contradict finance theory, it can be traced back to a long-forgotten paper on CAPM by Eugene Fama.
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