Accounting-Based Estimates of the Cost of Capital: A Third Way

69 Pages Posted: 24 Sep 2016 Last revised: 6 Oct 2016

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia Business School - Department of Accounting

Julie Lei Zhu

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2016

Abstract

This paper offers an approach for estimating the cost of capital from observed accounting information and compares the resulting estimates to so-called implied cost of capital (ICC) calculations and those from asset pricing models. The approach is based on two ideas. First, buying expected earnings growth is risky; thus, any variable that predicts expected earnings growth that is at risk of not being realized is potentially an indicator of the cost of capital. Second, accounting principles induce earnings growth that ties to risk; thus, an accounting number generated under these principles potentially indicates of the cost of capital. The paper combines such numbers into a cost-of-capital estimate. The estimates perform well in validation tests, in contrast to the alternatives that are the current standards.

Suggested Citation

Penman, Stephen H. and Zhu, Lei, Accounting-Based Estimates of the Cost of Capital: A Third Way (September 1, 2016). Available at SSRN: https://ssrn.com/abstract=2842269 or http://dx.doi.org/10.2139/ssrn.2842269

Stephen H. Penman (Contact Author)

Columbia Business School - Department of Accounting ( email )

3022 Broadway
New York, NY 10027
United States
212-854-9151 (Phone)
212-316-9219 (Fax)

Lei Zhu

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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