- 48 -
average, small companies have higher returns than large ones."
Ibbotson at 125 (citing Banz, The Relationship Between Returns
and Market Value of Common Stock, 9 J. Fin. Econ., 3-18 (1981)).
We have already alluded to the likelihood that small stocks will
have higher betas than larger stocks, because of greater risk.
See Ibbotson at 126. However, it has been found that the greater
risk of small stocks is not fully reflected by CAPM, in that
actual returns may exceed those expected based on beta. See id.
Consequently, when calculating a cost of capital under CAPM on a
small stock22, it is appropriate to add a small stock premium to
the equity risk premium, to reflect the greater risk associated
with an investment in a small stock in comparison to the large
stocks from which the equity-risk premium is calculated. Based
on Peoples' size, a microcapitalization equity size premium of
3.6 percent should have been added. See Ibbotson at 161.
Consequently, even if we accepted Mr. Fuller's beta of 1, which
we do not, Peoples' cost of capital should have been at least 18
percent.
b. Guideline Company Method
The market approach used by Mr. Fuller was the guideline
company method (guideline method). Under the guideline method,
22 There are actually three different premiums: (1) The mid-
capitalization equity size premium (capitalization between
$696 and $3,015 million); the low-capitalization equity size
premium ($171 million to $696 million); and (3) the
microcapitalization equity size premium (capitalization
below $171 million).
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