Abstract
Underperforming investments change a firm's equity value, cost of equity, capital structure and cost of capital. We show how to correctly adjust the cost of capital and correctly value a firm with underperforming investments. The correct equity estimate equates the equity value derived from the Economic Profit Model with the equity used to estimate the WACC. We demonstrate how underperforming investments can reduce equity value even though earnings may increase. We confirm our results with the Residual Earnings Model and show that our approach for valuing a company with underperforming investments also works well with investments that increase equity value.
Recommended Citation
(2026)
"The Cost of Underperforming Investments,"
Journal of Economics and Finance Education: Vol. 21:
Iss.
2, Article 5.
Available at:
https://scholarship.rollins.edu/jefe/vol21/iss2/5
