- 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).Page: Previous 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 Next
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