MV = Market value of equity
BV = Book value of equity
Thevaluesformarketvalueofequityandbook-to-priceratios
for individual firms, when plugged into this regression,
should yield expected monthly returns. For example, the
expected monthly return for a stock with a market
capitalizationof$100millionandabook-to-priceratioof0.5
would be:
Implied Rate of Return Models
Forpubliclytradedstocks,thereisathirdwayofestimating
thecostofequity.Ifweassumethatthemarketpriceisright
andwecanestimatethecashflowstoequity(oratleastthe
expecteddividends)onthestock,wecansolveforaninternal
rateofreturnthatwouldmakethepresentvalueofthecash
flowsequaltothestockprice.Thisinternalrateofreturnis
the implied cost of equity. For example, in the simplest
versionofthedividenddiscountmodel,thevalueofastock
can be written as follows:
Ifweassumethatthecurrentpriceofthestockisthecorrect
value and isolate the cost of equity, we get: