Estimating Cost of Capital in Firm Valuations with Arithmetic or Geometric Mean - Or Better Use the Cooper Estimator?

Abstract

We test the extent and determinants of bias effects of the arithmetic as well as the geometric mean estimator and the estimator of Cooper (1996) regarding discount rate estimation for firm valuation by way of a bootstrap approach for thirteen different countries. The Cooper estimator is preferable only for firms with small growth rates of future expected cash flows, while for moderate to high growth rates the “truncated” arithmetic mean estimator should be applied. This means that, in order to reduce problems of upward biased firm value estimates, expected cash flows beyond a certain time horizon are completely neglected. Such an approach seems particularly reasonable for the valuation of young growth companies as well as in general for companies from quickly developing countries like Brazil, China, or Thailand.