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Toward an Implied Cost of Capital
Author(s) -
Gebhardt William R.,
Lee Charles M. C.,
Swaminathan Bhaskaran
Publication year - 2001
Publication title -
journal of accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 6.767
H-Index - 141
eISSN - 1475-679X
pISSN - 0021-8456
DOI - 10.1111/1475-679x.00007
Subject(s) - cost of capital , residual income valuation , implicit cost , marginal cost of capital schedule , cost of equity , economics , weighted average cost of capital , return on capital , fixed capital , valuation (finance) , historical cost , capital budgeting , capital (architecture) , capital intensity , earnings , econometrics , equity (law) , microeconomics , capital formation , financial capital , finance , total cost , fair value , project appraisal , political science , profit (economics) , archaeology , law , history
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.