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COST OF CAPITAL AS A FUNCTION OF FINANCIAL LEVERAGE *
Author(s) -
MELNYK Z. LEW
Publication year - 1970
Publication title -
decision sciences
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.238
H-Index - 108
eISSN - 1540-5915
pISSN - 0011-7315
DOI - 10.1111/j.1540-5915.1970.tb00787.x
Subject(s) - leverage (statistics) , cost of capital , economics , weighted average cost of capital , capital structure , financial capital , function (biology) , microeconomics , operating leverage , relation (database) , point (geometry) , capital (architecture) , capital call , net income , business , finance , industrial organization , individual capital , computer science , profit (economics) , mathematics , debt , history , geometry , archaeology , database , machine learning , evolutionary biology , profitability index , biology
This study has three objectives. First, it develops new evidence on the sensitivity of cost of capital in relation to financial leverage. Second, the findings are interpreted in the light of the existing financial theory. The concept of shifting of cost of capital curves is also introduced and explored both in theory and in relation to empirical testing. Third, the conclusions are placed within the framework of financial management at the business firm level. To accomplish these objectives a new, heretofore untried, approach to testing the cost of funds to a firm has been developed. In contrast to the almost universally accepted cross‐section analysis, this study develops cost of capital functions for each company separately. Subsequently these functions are aggregated, compared, and also analyzed in a cross‐section fashion. This approach, in the opinion of the present author, is supported by the fact that (1) both the Net Operating Income and Net Income theories of cost of capital are stated in terms of a firm, not industry or other grouping of firms, and (2) from the practical point of view the question of optimality of capital structure is relevant, and indeed operationally meaningful, only at the firm level.