The cost of capital and how it affects climate change mitigation investment - Grantham Briefing Paper 15

Authors: Dr Charles Donovan and Christopher Corbishley

Key points

• The cost of capital, also known as the minimum required rate of return, is a crucial factor in investment decision-making in the private sector.
•  Assumptions made by government policymakers about cost of capital in the private sector often turn out to be wrong. These errors arise because the cost of capital amongst firms is highly disparate and nearly impossible to estimate precisely. 
• Cost of capital estimation errors have resulted in substantial economic welfare losses. Recent examples suggest that when governments take proper account of the cost of capital as an investment decision variable, outcomes for both the public and private sector are vastly improved.
• As the cost of capital for private sector investors is driven by risk perceptions, reducing investment risk is of paramount importance for governments seeking to minimize taxpayer support for new low-carbon infrastructure.
   

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