Toward an implied cost of capital

In this study, we propose an alternative technique for estimating the cost of equity capital. Specifically, we use a discounted residual income model to generate a market implied cost-of-capital. We then examine firm characte ristics that are systematically related to this estimate of cost-of-capital . Ve show that a firm's implied cost-of-capital is a function of its indust ry membership, B/M ratio, forecasted long-term growth rate, and the dispers ion in analyst earnings forecasts. Together, these variables explain around 60% of the cross-sectional variation in future (two-year-ahead) implied co sts-of-capital. The stability of these long-term relations suggests they ca n be exploited to estimate future costs-of-capital. We discuss the implicat ions of these findings for capital budgeting, investment decisions, and val uation research.