The Dependence of the Cost of Capital on Degree of Diversification

Abstract

The subject of this paper are theoretical and methodological aspects of determining the cost of capital on the example of two companies from the Energoprojekt system. The goal is to point out the most significant problems of determining the cost of capital in general, as well as to identify the most significant determinants of those costs. In addition, the paper has a goal to point out to the degree of impact of diversification of those two companies on the cost of their capital. Using the CAPM, the total cost of capital is calculated for Energoprojekt Holding and Energoprojekt Industrija. In accordance with that, the following hypotheses are formulated: (H0) The value of the beta coefficient of both enterprises is equal to zero, (H1) Volatility of the yield of shares of both companies is higher than the entire market, (H2) The total cost of the Holding's capital is lower than the total cost of the capital of Industrija and (H3) The largest component of the equity cost in both companies is the country risk premium. The first, second and third research hypotheses are confirmed in the paper, while the null hypothesis is rejected. The total cost of capital for Holding is equal to 14,80% and the total cost of capital for Industrija is 17,10%. The main component of the cost of equity is the risk premium of investing in Serbia, which is exceptionally high and is equal to 6,40%.

Keywords

• discount rate
• cost of equity
• CAPM
• diversification
• country risk premium