AN IMPROVED METHOD FOR ESTIMATING DISCOUNT RATES FOR LISTED COMPANY VALUATION

Yanfu Li

Accounting & Taxation, 2020, vol. 12, issue 1, 67-79

Abstract: This study offers a comprehensive overview of estimation methods for the discount rate used in company valuation, and then attempts to improve these methods. Firstly, for the cost of equity estimation method, this study improves the traditional form of build-up model by replacing its size premium with a betaadjusted size premium, so that the size premiums for firms in different size groups can be better reflected. Next, the study introduces an expanded capital asset pricing model (CAPM) which replaces the ordinary least square (OLS) beta with a shrunk beta. The beta-adjusted average size premium and the firm-specific risk premium were also added to capture unsystematic risk not measured by the traditional CAPM. In addition, this study introduces a target price-based multi-stage Gordon growth model, which adapts the consensus target price as a proxy of the intrinsic value in a manner consistent with the assumption of the basic Gordon growth model. The study continues by offering an effective solution to the estimation of cost of debt for companies above and below investment grade. The marginal tax rate and the forecasted rate on new debt issuance are recommended when estimate cost of debt. Finally, the study suggests a forwardlooking target capital structure to combine the cost of equity and cost of debt. The approach involves a three-step process to identify the possible target structure that firms are likely to adopt in the long term

Keywords: Discount Rate; Cost of Capital; Company Valuation (search for similar items in EconPapers)
JEL-codes: C10 G12 G14 (search for similar items in EconPapers)
Date: 2020
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