"ESTIMATING SYSTEMATIC RISK: THE CHOICE OF RETURN INTERVAL AND ESTIMATION
PERIOD"
Phillip R. Daves, Michael C. Ehrhardt, The University of Tennessee, Knoxville, TN
37996-0540
Robert A. Kunkel, Eastern Illinois University, Charleston, IL 61920
Capital budgeting is one of the most important strategic decisions that face financial managers. It is the process where the firm identifies, analyzes, and selects long-term projects. One popular technique to evaluate whether the project should be undertaken is the net present value method. A key ingredient of net present value is an accurately estimated weighted-average-cost-of-capital that is used to discount the future cash flows. The most difficult component of the weighted-average-cost-of-capital to calculate is the cost of equity. One approach to estimate the cost of equity is the Capital Asset Pricing Model approach where the financial manager estimates the firm
=s beta. A time-series regression is often used to estimate the beta and requires the financial manager to select both a return interval and an estimation period. This study examines the return interval and estimation period the financial manager should select when estimating beta. The results show that the financial manager should select the daily return interval and an estimation period of three years or less.