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

69 Pages Posted: 9 Oct 2017 Last revised: 12 Oct 2017

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia Business School - Department of Accounting

Julie Zhu

Fanhai International School of Finance(FISF), Fudan University

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2017

Abstract

This paper estimates the cost of capital from observed accounting information and compares the resulting estimates with so-called implied cost of capital (ICC) calculations and those from asset pricing models. The estimates are based on the idea that buying earnings growth is risky, and accounting numbers inform about that risk under accounting principles. First, accounting principles determine how much earnings are recognized currently or deferred to the future; that is accounting principles generate earnings growth. Second, these same principles connect the resulting growth to risk. Thus, an accounting number generated under these principles potentially indicates of the cost of capital, the required return for risk borne. The estimates perform well in validation tests, in contrast to the alternatives that are the current standards.

Suggested Citation

Penman, Stephen H. and Zhu, Julie, Accounting-Based Estimates of the Cost of Capital: A Third Way (February 1, 2017). Available at SSRN: https://ssrn.com/abstract=3049245 or http://dx.doi.org/10.2139/ssrn.3049245

Stephen H. Penman

Columbia Business School - Department of Accounting ( email )

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

Julie Zhu (Contact Author)

Fanhai International School of Finance(FISF), Fudan University ( email )

220 Handan Road
Shanghai, 200433
China

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