Estate of James Waldo Hendrickson - Page 48




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          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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