Toward an Implied Cost of Capital

2001/06/01 by William R. Gebhardt, Charles M. C. Lee, Charles M.C. Lee +1 · 1,987 citations
Business, Management and Accounting · Economics, Econometrics and Finance · #Capital (architecture) #Capital Investment and Risk Analysis #Capital budgeting #Capital formation #Capital intensity #Cost of capital #Cost of equity #Earnings #Econometrics #Economics #Equity (law) #Fair value #Finance #Financial Markets and Investment Strategies #Financial Reporting and Valuation Research #Financial capital #Fixed capital #Historical cost #Implicit cost #Marginal cost of capital schedule #Microeconomics #Residual income valuation #Return on capital #Total cost #Valuation (finance) #Weighted average cost of capital

paper · doi:10.1111/1475-679x.00007

published in Journal of Accounting Research 39(1), 135-176 (Wiley)

openalex publication_date 2001/06/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/04

Abstract

In this study, we propose an alternative technique for estimating the cost of equity capital. Specifically, we use a discounted residual income model to generate a market implied cost‐of‐capital. We then examine firm characteristics that are systematically related to this estimate of cost‐of‐capital. We show that a firm's implied cost‐of‐capital is a function of its industry membership, B/M ratio, forecasted long‐term growth rate, and the dispersion in analyst earnings forecasts. Together, these variables explain around 60% of the cross‐sectional variation in future (two‐year‐ahead) implied costs‐of‐capital. The stability of these long‐term relations suggests they can be exploited to estimate future costs‐of‐capital. We discuss the implications of these findings for capital budgeting, investment decisions, and valuation research.

Citations

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