Toward an Implied Cost of Capital

2001/06/01 by William R. Gebhardt, Charles M. C. Lee, Charles M.C. Lee +1 · 18 citations
Business, Management and Accounting · Economics, Econometrics and Finance · #Financial Reporting and Valuation Research #Capital Investment and Risk Analysis #Financial Markets and Investment Strategies

paper · doi:10.1111/1475-679x.00007

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

• Disclosure level and the cost of equity capital.
• Economic Forces and the Stock Market
• Risk, Return, and Equilibrium: Empirical Tests

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