Implied Cost of Capital over the Last 20 Years

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  • <b>Implied Cost of Capital over the Last 20 Years</b>

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The purpose of this paper is to estimate an alternative implied cost of capital, as inferred from a valuation model, and to attempt to compare its validity. We compare the following major five models: 1) a model proposed by Gebhardt et al. (2001); 2) a model suggested by Ohlson and Juettner-Nauroth (2005); 3) an expected earnings to price ratio (EP ratio); 4) a PEG ratio; and 5) a modifi ed PEG ratio (the last two being proposed by Easton (2004)). For the criteria of valuation in this study, we focused on the following two points: first, a significant correlation with the risk factors consistent with the expected signs and, second, that the coefficients have the expected sign and that the adjusted R-square is high in the multivariate models that regress the cost of capital on the risk factors. As a result, we conclude that the PEG and modified PEG ratios are superior to other models. Furthermore, we suggest that the correlation between the cost of capital and the risk factors varies, depending on the periods. Although Gode and Mohanram (2003) pointed out that the difference in the cost of capital by industry is important, this study shows that the diff erence in the time series of the cost of capital is more important in Japan.

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