SWM - Mark Moore

Size-Adjusted Cost of EquityThe CAPM is the most commonly used method in determining cost of equity, but someanalysts believe it may not be a complete method. The size-adjusted cost of equity is anothermethod that can be used to find the Ke. Size-adjusted cost of equity suggests that factorsother than systematic risk play a part in determining return, like size. Smaller firms are knownto give larger returns as larger firms give smaller returns. Size-adjusted Ke is used to take intoaccount the varying sizes of firms. The size-adjusted cost of equity can be found with thefollowing formula:Ke = Risk Free Rate + Beta(Market Risk Premium)Size Adjusted Ke: 0.1462 = 0.004 + 1.49 (0.08) + 0.023Size-adjusted cost of equity is essentially the same as the CAPM plus size premium. Sizepremium is determined by size deciles ranging from 1 to 10. 1 represents the smallest firmsand progresses to 10, which represents the largest firms. Market capitalization is used todetermine which decline a firm is located in. We calculated Schweitzer-Mauduit’s market cap tobe $780.55 million. This gives the firm a market size of 2.3%. The cost of equity is estimatedto be 14.62%, which is a reasonable estimate because it falls within the 95% confidenceinterval found earlier.Alternative Cost of Equity Estimation MethodThe alternative cost of equity estimation method, also known as the backdoor cost ofequity, is another method used to solve for Ke. This method takes into consideration thecurrently observed stock price. It is computed very differently from CAPM because it uses theprice to book ratio, ROE, and a growth rate. The price to book ratio considers the currentmarket price of the firm. We calculated the P/B ratio to be 2.53. ROE was computed byaveraging the forecasted lagged ROE’s for the next ten years, 2009-2018, which was 7.12%.151