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

21 Pages Posted: 25 May 2006

See all articles by Peter D. Easton

Peter D. Easton

University of Notre Dame - Department of Accountancy

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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 payoffs (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.

Suggested Citation

Easton, Peter D., Use of Forecasts of Earnings to Estimate and Compare Cost of Capital Across Regimes. Journal of Business Finance & Accounting, Vol. 33, No. 3-4, pp. 374-394, April 2006, Available at SSRN: https://ssrn.com/abstract=903459 or http://dx.doi.org/10.1111/j.1468-5957.2006.00627.x

Peter D. Easton (Contact Author)

University of Notre Dame - Department of Accountancy ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States
574-631-6096 (Phone)
574-631-5127 (Fax)

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