Measuring the Cost of Capital in Australia

The cost of capital is the minimum rate of return that an investment project must earn in order to cover its funding costs and any tax liabilities. Australian studies on this subject have produced a wide range of estimates. This paper demonstrates that a wide range of outcomes can result from often arbitrary assumptions used in constructing measures of the cost of funds. The paper suggests that any conclusions drawn about intertemporal trends or international comparisons of the cost of capital should be treated with care. For managers, it serves as a reminder that the use of simple invariant rules-of-thumb for investment decisions may be inappropriate. In particular, changes of tax regime and inflation should be taken into account in setting ‘hurdle rates’ for investment proposals.