Toward an Implied Cost of Capital

Posted: 21 Feb 2001

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

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: M41, G12, G31

Suggested Citation

Gebhardt, William R. and Lee, Charles M.C. and Swaminathan, Bhaskaran, Toward an Implied Cost of Capital. Journal of Accounting Research. Available at SSRN: https://ssrn.com/abstract=254768

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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