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Ch 15 - Ch 15 Cost of Capital In this chapter the important...

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Ch 15 Cost of Capital
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In this chapter, the important fact to note is that the return an investor in a security receives is the cost of that security to the firm that issued it. 1) Cost of Equity (1) Dividend growth model g P D R g R D P E E + = - = 0 1 1 0 / ) (
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Estimating g (growth rate): (1) historical growth rate or (2) analyst’ s forecasts of future growth rate. Arithmetic and geometric averages could be used. Problems: - Applicable to firms paying dividends. - Sensitive to growth rate. - Not consider risks. (2) SML approach. ] ) ( [ ) ( f m E f E R R E R R E - × + = β
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Advantages: - Adjusted for risk - Applicable to firms not paying dividends Disadvantages: - Reliance on estimates. - Reliance on the past in order to estimate beta.
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2) Cost of debts Yield to Maturity after Tax Cost of debts = YTM * (1-t) 3) Cost of preferred stocks 0 P D R P =
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4) Weighted Average Cost of Capital Hurdle rate to screen projects Minimum rate to maintain the current capital structure
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