Terminal valuations, growth rates and the implied cost of capital

Terminal valuations, growth rates and the implied cost of capital We develop a model based on the notion that prices lead earnings, allowing for a simultaneous estimation of the implied growth rate and the cost of equity capital for US industrial sectors. The major difference between our approach and that in prior literature is that ours avoids the necessity to make assumptions about terminal values and consequently about future growth rates. In fact, growth rates are an endogenous variable, which is estimated simultaneously with the implied cost of equity capital. Since we require only 1-year-ahead forecasts of earnings and no assumptions about dividend payouts, our methodology allows us to estimate ex ante aggregate growth and risk premia over a larger sample of firms than has previously been possible. Our estimate of the risk premium being between 3.1 and 3.9 % is at the lower end of recent estimates, reflecting the inclusion of these short-lived companies. Our estimate of the long run growth is from 4.2 to 4.7 %. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Terminal valuations, growth rates and the implied cost of capital

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Publisher
Springer Journals
Copyright
Copyright © 2012 by The Author(s)
Subject
Economics / Management Science; Accounting/Auditing; Finance/Investment/Banking; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-012-9208-5
Publisher site
See Article on Publisher Site

Abstract

We develop a model based on the notion that prices lead earnings, allowing for a simultaneous estimation of the implied growth rate and the cost of equity capital for US industrial sectors. The major difference between our approach and that in prior literature is that ours avoids the necessity to make assumptions about terminal values and consequently about future growth rates. In fact, growth rates are an endogenous variable, which is estimated simultaneously with the implied cost of equity capital. Since we require only 1-year-ahead forecasts of earnings and no assumptions about dividend payouts, our methodology allows us to estimate ex ante aggregate growth and risk premia over a larger sample of firms than has previously been possible. Our estimate of the risk premium being between 3.1 and 3.9 % is at the lower end of recent estimates, reflecting the inclusion of these short-lived companies. Our estimate of the long run growth is from 4.2 to 4.7 %.

Journal

Review of Accounting StudiesSpringer Journals

Published: Aug 14, 2012

References

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