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Equity value, implied cost of equity and shareholders’ real options
Author(s) -
Sohn Byungcherl Charlie
Publication year - 2012
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/j.1467-629x.2011.00404.x
Subject(s) - equity (law) , abandonment (legal) , residual income valuation , cost of equity , economics , shareholder , equity capital markets , financial economics , residual , implicit cost , equity value , equity ratio , business , finance , cost of capital , microeconomics , private equity , debt , total cost , mathematics , profit (economics) , corporate governance , algorithm , debt levels and flows , external debt , political science , law
This study investigates the effects of shareholders’ real options on (i) firm financial performance and (ii) estimations of the implied cost of equity. After measuring the equity value of steady‐state operations using the residual income model, and the abandonment and expansion options using the Black‐Scholes option pricing model, I find that firms with a large expansion (abandonment) option value experience better (worse) financial performance than those with a small such value. I also find that ignoring these options results in a downward bias in implied cost of equity estimates by an average of 1.23 percentage points.