We estimate required rates of return on equity for all firms listed in the first section of the Tokyo Stock Exchange using both CAPM and Fama and French three-factor model with monthly datafrom January 1980 through December 1999. We report the summary statistics at the industry level to compare the equity cost of capital among industries. We also compare the cost of equity for Japan with the US result by Fama and French (1998) at the industry level. Then, we estimate the weighted-average cost of capital, excluding financial firms, by computing the effective interest rates and the average tax rates for each firm using the actual data. At a next step, we compute the marginal cost of capital for typical Japanese firms in each industry. To do so, we use both originalMiller and Modigliani tax correction model and the after-tax value relationship formulation byMiller (1977) before the Miller equilibrium gets reached. By using reasonable parameter valuesbased on the prevalent and the hypothetical corporate and individual income tax rates for Japan, we demonstrate how tax change policies can affect the cost of capital for Japan, and, hence, the capital allocations in the economy. Finally, we investigate the association between the long run trends ofreturn on equity, the equity premium, and the productivity growth rates, and show how aggregatecost of capital changes along with business cycle changes.
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