Toward an Implied Cost of Capital

Parker Center for Investment Research Working Paper

78 Pages Posted: 27 Dec 2000

See all articles by William R. Gebhardt

William R. Gebhardt

affiliation not provided to SSRN

Charles M.C. Lee

Stanford University - Graduate School of Business

Bhaskaran Swaminathan

LSV Asset Management

Multiple version iconThere are 2 versions of this paper

Date Written: October 27, 2000

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.

Keywords: Valuation; Equity; Cost of capital; Residual income; Discounted cash flow; Capital budgeting; Investments; Earnings forecasts

JEL Classification: M40, M41, M46, G31

Suggested Citation

Gebhardt, William R. and Lee, Charles M.C. and Swaminathan, Bhaskaran, Toward an Implied Cost of Capital (October 27, 2000). Parker Center for Investment Research Working Paper. Available at SSRN: https://ssrn.com/abstract=254523 or http://dx.doi.org/10.2139/ssrn.254523

William R. Gebhardt

affiliation not provided to SSRN

Charles M.C. Lee (Contact Author)

Stanford University - Graduate School of Business ( email )

Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305-5015
United States
650-721-1295 (Phone)

Bhaskaran Swaminathan

LSV Asset Management ( email )

155 North Wacker Drive
Chicago, IL 60606
United States

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