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unreasonably low; using a beta greater than 1 would increase the
discount rate used in the Fuller analysis, thereby decreasing the
value otherwise computed. We do not believe that an investment
in Peoples, a small, single-location bank, whose earnings were
susceptible to impending interest rate mismatches and sluggish
local economic conditions, presents the same systematic risk as
an investment in an index fund holding shares in 500 of the
largest corporations in the United States.
In calculating the discount rate, Mr. Fuller used an equity
risk premium of 7.3 percent, "based on the average share of
common stock of publicly traded companies", and cited Ibbotson.
We think that Mr. Fuller meant Ibbotson's long-horizon equity
risk premium, which represents the total returns of large company
stocks, less the long-term risk-free rate, which is widely used
in calculating a cost of capital under CAPM.
Although Mr. Fuller cited Ibbotson as his source for equity
risk premium, in his initial report he ignored a crucial aspect
of the Ibbotson approach to constructing a cost of capital--the
small stock premium. In his rebuttal report, Mr. Fuller
unsuccessfully tried to persuade us that the small stock premium
is not supported by financial theory, characterizing the risk
associated with a firm's size as unsystematic risk, for which the
market does not compensate. The relationship between firm size
and return is well known. Size is not an unsystematic risk
factor and cannot be eliminated through diversification. "On
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