IDEAS home Printed from https://ideas.repec.org/a/bla/eufman/v14y2008i5p989-1006.html
   My bibliography  Save this article

Required Rates of Return for Corporate Investment Appraisal in the Presence of Growth Opportunities

Author

Listed:
  • Ian R. C. Hirst
  • Jo Danbolt
  • Eddie Jones

Abstract

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.

Suggested Citation

  • Ian R. C. Hirst & Jo Danbolt & Eddie Jones, 2008. "Required Rates of Return for Corporate Investment Appraisal in the Presence of Growth Opportunities," European Financial Management, European Financial Management Association, vol. 14(5), pages 989-1006, November.
    • Handle: RePEc:bla:eufman:v:14:y:2008:i:5:p:989-1006
    DOI: 10.1111/j.1468-036X.2007.00406.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1468-036X.2007.00406.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1468-036X.2007.00406.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Renneboog, L.D.R. & Trojanowski, G., 2005. "Patterns in Payout Policy and Payout Channel Choice of UK Firms in the 1990s," Discussion Paper 2005-002, Tilburg University, Tilburg Law and Economic Center.
    2. Kee H. Chung & Kyu H. Kim, 1997. "Growth Opportunities and Investment Decisions: A New Perspective on the Cost of Capital," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(3), pages 413-424.
    3. Myers, Stewart C & Turnbull, Stuart M, 1977. "Capital Budgeting and the Capital Asset Pricing Model: Good News and Bad News," Journal of Finance, American Finance Association, vol. 32(2), pages 321-333, May.
    4. Kee H. Chung & Kyu H. Kim, 1997. "Growth Opportunities and Investment Decisions: A New Perspective on the Cost of Capital," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(3), pages 413-424, April.
    5. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    6. Rajan, Raghuram G & Zingales, Luigi, 1995. "What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-1460, December.
    7. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411-411.
    8. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-985, December.
    9. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    10. repec:bla:jfinan:v:43:y:1988:i:1:p:1-19 is not listed on IDEAS
    11. Jo Danbolt & Ian Hirst & Edward Jones, 2002. "Measuring growth opportunities," Applied Financial Economics, Taylor & Francis Journals, vol. 12(3), pages 203-212.
    12. Moshe Ben-Horim & Jeffrey L Callen, 1989. "THE COST OF CAPITAL, MACAULAY'S DURATION, AND TOBIN'S q," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 12(2), pages 143-156, June.
    13. Lang, Larry H. P. & Stulz, ReneM. & Walkling, Ralph A., 1989. "Managerial performance, Tobin's Q, and the gains from successful tender offers," Journal of Financial Economics, Elsevier, vol. 24(1), pages 137-154, September.
    14. Elroy Dimson & Paul Marsh & Mike Staunton, 2003. "Global Evidence On The Equity Risk Premium," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(4), pages 27-38, September.
    15. Kee H. Chung & Charlie Charoenwong, 1991. "Investment Options, Assets in Place, and the Risk of Stocks," Financial Management, Financial Management Association, vol. 20(3), Fall.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Manuel Rocha Armada & Lawrence Kryzanowski & Paulo Jorge Pereira, 2011. "Optimal Investment Decisions for Two Positioned Firms Competing in a Duopoly Market with Hidden Competitors," European Financial Management, European Financial Management Association, vol. 17(2), pages 305-330, March.
    2. Jo Danbolt & Ian Hirst & Eddie Jones, 2011. "The growth companies puzzle: can growth opportunities measures predict firm growth?," The European Journal of Finance, Taylor & Francis Journals, vol. 17(1), pages 1-25.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jo Danbolt & Ian Hirst & Eddie Jones, 2011. "The growth companies puzzle: can growth opportunities measures predict firm growth?," The European Journal of Finance, Taylor & Francis Journals, vol. 17(1), pages 1-25.
    2. Paulo, Alves, 2018. "Abnormal retained earnings around the world," Journal of Multinational Financial Management, Elsevier, vol. 46(C), pages 63-74.
    3. Richard W. Kopcke, 1992. "Tobin's Q, economic rents, and the optimal stock of capital," Working Papers 92-3, Federal Reserve Bank of Boston.
    4. Juan M. San Martin-Reyna & Jorge A. Durán-Encalada, 2012. "Ownership Structure, Earnings Management and Investment Opportunity Set: Evidence from Mexican Firms," Journal of Entrepreneurship, Management and Innovation, Fundacja Upowszechniająca Wiedzę i Naukę "Cognitione", vol. 8(3), pages 35-57.
    5. Gul, Ferdinand A., 1999. "Growth opportunities, capital structure and dividend policies in Japan," Journal of Corporate Finance, Elsevier, vol. 5(2), pages 141-168, June.
    6. Pablo De Andrés‐Alonso & Valentín Azofra‐Palenzuela & Gabriel De La Fuente‐Herrero, 2006. "The Real Options Component of Firm Market Value: The Case of the Technological Corporation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(1‐2), pages 203-219, January.
    7. Rongrong Zhang & Yoshio Kanazaki, 2007. "Testing static tradeoff against pecking order models of capital structure in Japanese firms," Accounting Research Journal, Emerald Group Publishing, vol. 15(2), pages 24-36, June.
    8. San Martín, Pablo & Saona, Paolo, 2017. "Capital structure in the Chilean corporate sector: Revisiting the stylized facts," Research in International Business and Finance, Elsevier, vol. 40(C), pages 163-174.
    9. Seyed Alireza Athari, 2021. "The effects of institutional settings and risks on bank dividend policy in an emerging market: Evidence from Tobit model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(3), pages 4493-4515, July.
    10. Basil Al-Najjar, 2011. "The inter-relationship between capital structure and dividend policy: empirical evidence from Jordanian data," International Review of Applied Economics, Taylor & Francis Journals, vol. 25(2), pages 209-224.
    11. A. A. Bevan & J. Danbolt, 2004. "Testing for inconsistencies in the estimation of UK capital structure determinants," Applied Financial Economics, Taylor & Francis Journals, vol. 14(1), pages 55-66.
    12. Szilagyi, P.G., 2007. "Corporate governance and the agency costs of debt and outside equity," Other publications TiSEM 9520d40a-224f-43a8-9bf9-b, Tilburg University, School of Economics and Management.
    13. Justin Lallemand, 2020. "Bank lending to targets of active takeover attempts: The simultaneous choice of loan maturity, pricing, and security," Review of Financial Economics, John Wiley & Sons, vol. 38(2), pages 332-351, April.
    14. Luca Riccetti & Alberto Russo & Mauro Gallegati, 2015. "An agent based decentralized matching macroeconomic model," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 10(2), pages 305-332, October.
    15. Koh, SzeKee & Durand, Robert B. & Watson, Iain, 2011. "Seize the moment: Opportunism in Australian capital markets," Pacific-Basin Finance Journal, Elsevier, vol. 19(4), pages 374-389, September.
    16. Tåg, Joacim, 2010. "The Real Effects of Private Equity Buyouts," Working Paper Series 851, Research Institute of Industrial Economics.
    17. Christoph Börner & Dietmar Grichnik & Frank Reize, 2010. "Finanzierungsentscheidungen mittelständischer Unternehmer — Einflussfaktoren der Fremdfinanzierung deutscher KMU," Schmalenbach Journal of Business Research, Springer, vol. 62(2), pages 227-275, March.
    18. repec:dau:papers:123456789/9153 is not listed on IDEAS
    19. Drobetz, Wolfgang & Pensa, Pascal & Wöhle, Claudia B., 2004. "Kapitalstrukturtheorie in Theorie und Praxis: Ergebnisse einer Fragebogenuntersuchung," Working papers 2004/09, Faculty of Business and Economics - University of Basel.
    20. Didier, Tatiana & Levine, Ross & Llovet Montanes, Ruth & Schmukler, Sergio L., 2021. "Capital market financing and firm growth," Journal of International Money and Finance, Elsevier, vol. 118(C).
    21. Kamal Naser & Abdullah Al-Mutairi & Ahmad Al Kandari & Rana Nuseibeh, 2015. "Cogency of Capital Structure Theories to an Islamic Country: Empirical Evidence from the Kuwaiti Banks," International Journal of Economics and Financial Issues, Econjournals, vol. 5(4), pages 979-988.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:eufman:v:14:y:2008:i:5:p:989-1006. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/efmaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.