Best Practice for Cost-of-Capital Estimates

Cost-of-capital assessments with factor models require quantitative forward- looking estimates. We recommend estimating Vasicek-shrunk betas with one to four years of daily stock returns, and then — because the underlying betas are themselves time-varying — shrinking betas a second time (and more for smaller stocks and longer-term projects). Such estimators also worked well in other OECD countries and for SMB and HML exposures. If own historical stock returns are not available, market cap-based peer betas should be used. Historical industry averages have almost no predictive power and should never be used