Pricing the Idiosyncratic Risk in the Cost of Capital: A Comprehensive Model

Despite the mixed evidence, recent empirical works highlight importance of idiosyncratic risk in stock market. On this basis, note elaborates an approach to price directly specific cost capital, both for scientific purposes and practitioner’s investment valuation. For extremely high leverage values, risky debt tends approximate unlevered capital. Exploiting a Merton model, we show simple solution calculate practice every capital version, providing comprehensive framework. A worked example is provided simplify concrete application.