Released: V.10, N1

R. G. Ibragimov. Effect of Nonmarket Debt Financing on the Cost of Capital and Firm Value

V.5, N1, 2007

To make economically sound capital allocation decisions at the corporate level, and to evaluate current performance of the business units, we need a hurdle rate to distinguish between value creation and value destruction. This hurdle rate is the cost of capital, so the quality of managerial decisions depends directly on the quality of the cost of capital estimates. In the paper we analyze effect of the debt financing with nonmarket interest rate on the cash flows redistribution, firm’s capital structure and the firm value. We propose methodology to calculate the cost of levered equity and the weighted average cost of capital for the firm with subsidized debt, illustrate with a numerical example that all discounted cash flow value estimates match, and show consequences of applying incorrect approach to the cost of capital calculation.