Abstract
The valuation of the firm and its assets has been done for a long time in the classic context of complete information. Several empirical tests of the main valuation methods reveal a divergence between theoretical prices and observed prices. These deviations might be explained by the standard assumptions of complete information. It is possible to introduce information uncertainty as done by Merton and by Bellalah in the reexamination of corporate risks in the presence of information costs. The concept of risk is useful in modelling the value of the firm and its business risk and in the definition of the required rates of return and the cost of capital of corporations. However, the main well‐known results ignore information uncertainty as defined by Merton. Using the main results from the study of Modigliani and Miller and the implications of Merton's model, we give expressions for the cost of capital and the value of the firm's equity and debt in the presence of information costs. We reexamine the relationships between interrelated risks in the same context. We introduce information costs in the computation of the cost of capital and in the pricing of equity in an option framework. When there are no information costs, the main relationships reduce to the classic results in the literature. Copyright © 2001 John Wiley & Sons, Ltd.