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The implied cost of capital: accounting for growth

Author

Listed:
  • Stephen Penman

    (Columbia University
    Bocconi University)

  • Julie Zhu

    (Fudan Fanhai School of Business)

  • Haofei Wang

    (Shanghai Jiao Tong University)

Abstract

This paper involves a critique of the Implied Cost of Capital (ICC) that leads to an alternative measure which, like the ICC, is extracted from accounting data. The critique deals with how the ICC handles the accounting involved. First, the ICC fails an accounting consistency condition. Second, expected earnings growth conveys risk and return, but this is not recognized when a growth rate is inserted in the reverse engineering exercise. Empirical tests so confirm. An alternative accounting-based measure accommodates these points and validates on criteria indicating risk and return. The resulting measure is a yield to maturity for equities, much like that for a bond.

Suggested Citation

  • Stephen Penman & Julie Zhu & Haofei Wang, 2023. "The implied cost of capital: accounting for growth," Review of Quantitative Finance and Accounting, Springer, vol. 61(3), pages 1029-1056, October.
    • Handle: RePEc:kap:rqfnac:v:61:y:2023:i:3:d:10.1007_s11156-023-01175-y
    DOI: 10.1007/s11156-023-01175-y
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    References listed on IDEAS

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    More about this item

    Keywords

    Implied cost of capital; Earnings growth and risk; Yield to maturity;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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