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Required Rates of Return for Corporate Investment Appraisal in the Presence of Growth Opportunities
Author(s) -
Hirst Ian R. C.,
Danbolt Jo,
Jones Eddie
Publication year - 2008
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2007.00406.x
Subject(s) - equity (law) , economics , rate of return , investment (military) , return on investment , return on equity , value (mathematics) , financial economics , monetary economics , business , finance , microeconomics , profitability index , profit (economics) , statistics , mathematics , politics , political science , law
Traditional methods of estimating required rates of return overstate hurdle rates in the presence of growth opportunities. We attempt to quantify this effect by developing a simple model which: (i) identifies those companies that have valuable growth opportunities; (ii) splits the value of shares into ‘assets‐in‐place’ and ‘growth opportunities’; and (iii) splits the equity β into β for ‘assets‐in‐place’ and ‘growth opportunities’. We find growth opportunities for UK companies over the 1990–2004 period to average 33% of equity value. Incorporating the effect of growth opportunities, the average cost of capital for investment purposes falls by 1.1 percentage points.