Mispricing and the Cost of Capital: The Example of Tesla

Abstract

Sentiment based mispricing of a common stock can be interpreted as a subsidy that reduces the cost of capital. The subsidy is provided by the investors who are willing to accept a lower return than the “true” cost capital. In the case of Tesla, I estimate the subsidy to be 248 basis points. To the extent that sentiment-based mispricing can be realized by issuing new shares at a lower effective cost of capital, Tesla has a significant competitive advantage over incumbent auto makers that is exacerbated by the capital-intensive nature of the business. This results in a feedback from stock market pricing to fundamental value. The feedback mechanism is a significant threat to traditional car makers.

Keywords: valuation, cost of capital, mispricing

JEL Classification: G00, G10