| Abstract: | The authors develop a new way to measure the cost of capital, called the empirical average cost of capital (or “EACC”), which is consistent with existing methods of calculating the weighted average cost of capital, but uses information from the firm's financial statements and requires fewer and less subjective inputs. The authors’ model relies on the concept of economic profit while using data from the period 1990‐2012 on net operating profits and total capital to estimate the EACC at both the individual company and industry‐wide levels. Estimates of the EACC and rolling quarterly forecasts of future net operating profits for a single company, McDonald's, for its related industry, and for 57 other U.S. industries are compared to five conventional “textbook” estimates of the weighted average cost of capital published by Ibbotson Associates. The authors find that the EACC yields forecasts of future net operating profit after taxes that compare favorably to those of the five published measures of the weighted average cost of capital, as well as the average and median of these measures. |
