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Use of Forecasts of Earnings to Estimate and Compare Cost of Capital Across Regimes

Use of Forecasts of Earnings to Estimate and Compare Cost of Capital Across Regimes Abstract: I critically examine several of the methods used in the recent literature to estimate and compare the cost of capital across different accounting/regulatory regimes. I focus on the central importance of expectations of growth beyond the short period for which forecasts of future pay‐offs (dividends and/or earnings) are available. I illustrate, using the stocks that comprised the Dow Jones Industrial Average (DJIA) at December 31, 2004, as an example, the differences between the growth rates implied by the data, and growth rates that are often assumed in the literature. My analyses show that assumptions about growth beyond the (short) forecast horizon may seriously affect the estimates of the expected rate of return and may lead to spurious inferences. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Business Finance & Accounting Wiley

Use of Forecasts of Earnings to Estimate and Compare Cost of Capital Across Regimes

Journal of Business Finance & Accounting , Volume 33 (3‐4) – Apr 1, 2006

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References (44)

Publisher
Wiley
Copyright
Copyright © 2006 Wiley Subscription Services, Inc., A Wiley Company
ISSN
0306-686X
eISSN
1468-5957
DOI
10.1111/j.1468-5957.2006.00627.x
Publisher site
See Article on Publisher Site

Abstract

Abstract: I critically examine several of the methods used in the recent literature to estimate and compare the cost of capital across different accounting/regulatory regimes. I focus on the central importance of expectations of growth beyond the short period for which forecasts of future pay‐offs (dividends and/or earnings) are available. I illustrate, using the stocks that comprised the Dow Jones Industrial Average (DJIA) at December 31, 2004, as an example, the differences between the growth rates implied by the data, and growth rates that are often assumed in the literature. My analyses show that assumptions about growth beyond the (short) forecast horizon may seriously affect the estimates of the expected rate of return and may lead to spurious inferences.

Journal

Journal of Business Finance & AccountingWiley

Published: Apr 1, 2006

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