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COST OF CAPITAL
These are specific costs of using long-term
funds, obtained from the different
sources: borrowed (debt) and invested
(equity) capital.
Cost of Debt
Source: Creditors
Formula:
Preferred dividend per share
Current market price or Net issuance
price
Cost of Common Stock/Retained
Earnings
Source: Common Stockholders
Formula:
Expected cash divided per share + DGR*
Market price per common share
2/25 + 5% = 13%
Cost of Common Stock
What would be the cost of new common
stock equity for Klay Corp. if the firm
expects a dividend of $4.25, the stock
price is $55.00, dividends are expected
to grow at 8.5 percent indefinitely, and
flotation costs are $6.25 per share?
Cost of Common Stock
What would be the cost of new common
stock equity for Klay Corp. if the firm
expects a dividend of $4.25, the stock
price is $55.00, dividends are expected
to grow at 8.5 percent indefinitely, and
flotation costs are $6.25 per share?
Ke = Cost of Equity
Rf = Risk-free rate determined by
government securities
B = Beta coefficient
Rm = market return
CAPM
Benjamin Corporation wishes to determine
the required return on an asset Z, which
has a beta of 1.5. The risk-free rate of
return is 7%; the return on the market
portfolio of assets is 11%. What is the
cost of equity?
CAPM
Benjamin Corporation wishes to determine
the required return on an asset Z, which
has a beta of 1.5. The risk-free rate of
return is 7%; the return on the market
portfolio of assets is 11%.
Ke = 7% + 1.5(11%-7%)
Ke = 13%
CAPM
Button Corporation has a beta of 1.25, a
risk-free rate of 8% and a market risk
premium of 5%. What is the
corporations cost of equity.
CAPM
Button Corporation has a beta of 1.25, a
risk-free rate of 8% and a market risk
premium of 5%. What is the
corporations cost of equity.
Re = 8% + 1.25(5%)
Re = 14.25%