A note on estimating the divisional cost of capital for diversified companies: an empirical evaluation of heuristic-based approaches

This note provides an empirical analysis of the potential for heuristic-based approaches to derive a divisional cost of equity from a firm's total cost of capital. Since an empirical relationship between fundamental information and systematic risk has previously been shown in other studies, idiosyncratic information on risk and performance ought to serve as a good proxy to calculate divisional adjustments. Two practically used, heuristic-based approaches are tested and a significant relationship is found between one of the measures and CAPM beta. This method may offer a plausible and comparatively uncomplicated method for adjusting a firm's total cost of capital for divisional use.