IDEAS home Printed from https://ideas.repec.org/a/sae/ausman/v36y2011i2p125-149.html
   My bibliography  Save this article

Properties of implied cost of capital using analysts’ forecasts

Author

Listed:
  • Wayne Guay

    ()

  • SP Kothari
  • Susan Shu

Abstract

We evaluate the influence of measurement error in analysts’ forecasts on the accuracy of implied cost of capital estimates from various implementations of the ‘implied cost of capital’ approach, and develop corrections for the measurement error. The implied cost of capital approach relies on analysts’ short- and long-term earnings forecasts as proxies for the market’s expectation of future earnings, and solves for the implied discount rate that equates the present value of the expected future payoffs to the current stock price. We document predictable error in the implied cost of capital estimates resulting from analysts’ forecasts that are sluggish with respect to information in past stock returns. We propose two methods to mitigate the influence of sluggish forecasts on the implied cost of capital estimates. These methods substantially improve the ability of the implied cost of capital estimates to explain cross-sectional variation in future stock returns, which is consistent with the corrections being effective in mitigating the error in the estimates due to analysts’ sluggishness.

Suggested Citation

  • Wayne Guay & SP Kothari & Susan Shu, 2011. "Properties of implied cost of capital using analysts’ forecasts," Australian Journal of Management, Australian School of Business, vol. 36(2), pages 125-149, August.
  • Handle: RePEc:sae:ausman:v:36:y:2011:i:2:p:125-149
    as

    Download full text from publisher

    File URL: http://aum.sagepub.com/content/36/2/125.abstract
    Download Restriction: no

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sae:ausman:v:36:y:2011:i:2:p:125-149. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (SAGE Publications). General contact details of provider: http://www.agsm.edu.au .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.