Abstract:
This paper shows that, in the presence of differential taxation of
ordinary income and capital gains, use of the Officer (1994) version
of the Capital Asset Pricing Model can result in significant misestimation
of the cost of equity capital. In particular, with a high
dividend yield, the cost of equity may be underestimated by four
percentage points. Underestimation is of particular significance in
the context of setting output prices for regulated utility firms.
