Estimating An Implied Cost of Capital for Australian Firms

Abstract

We find that a composite implied cost of capital (ICC) estimate - based on the earnings forecasts generated by cross-sectional models is highly correlated with future realised returns in both portfolio- and regression-based tests. By contrast, we find very little evidence for an association with future realised returns for an ICC estimate based on analyst earnings forecasts. We also document the time-varying nature of expected returns and risk premia, and provide up-to-date estimates of an implied Australian market risk premium. Additionally, we provide industry-level estimates; highlighting differences in expected returns and risk perceptions across sectors.

Keywords: cost of capital, earnings estimates, analyst forecasts

JEL Classification: G12, G14