Title: A preliminary framework to estimate and disclose ex-ante cost of capital for (fair) valuation

Authors: Josilmar Cordenonssi Cia; Joanília Neide De Sales Cia; Luiz Carlos Jacob Perera

Addresses: Universidade Presbiteriana Mackenzie, Av. Paulista, 1195 AP. 141, CEP: 01311-922, São Paulo/SP, Brazil ' Universidade de São Paulo, Av. Paulista, 1195 AP. 141, CEP: 01311-922, São Paulo/SP, Brazil ' Universidade Presbiteriana Mackenzie, Rua da Consolação, 896, CEP: 01302-907, São Paulo/SP, Brazil

Abstract: Fair-value accounting is usually seen as a rule to mark assets to market. While the market was bullish, there was little concern about the implications of a potential downside risk of fair value rules. But with the current world financial crisis triggered by US subprime loans default, pressure surged for it is simply extinction or at least for more flexibility to apply what 'fair' should really mean according to managers' judgment. Critics of fair-value (mark-to-market) accounting raise the question that in some moments market prices decouple from the 'fundamentals' and using it as the value reference can distort financial statements. In other words, they posit that market are not always efficient, markets are prone to positive and negative price bubbles. This is a preliminary work that aims to estimate ex-ante cost of capital (or expected rate of return) using market data and some parameters, like expected equity market risk-premium, its volatility and an average relative risk-aversion of a representative agent. In other words, the main objective is to establish a framework of assumptions, in order to do and disclose inherently subjective estimates of equity market portfolio (or index) ex-ante expected rate of return, in a theoretical coherent manner.

Keywords: fair value accounting; cost of capital; CAPM; risk aversion; expected utility theorem; fair valuation; expected rate of return.

DOI: 10.1504/IJMDA.2016.081089

International Journal of Multivariate Data Analysis, 2016 Vol.1 No.1, pp.61 - 75

Received: 12 Oct 2016
Accepted: 13 Oct 2016
Published online: 20 Dec 2016 *