chapter12a - Chapter 12: Cost of Capital Know how to...

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Chapter 12: Cost of Capital Know how to determine a firm’s cost of equity capital Know how to determine a firm’s overall cost of capital
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2 Cost of Capital Cost of capital and required return: The return to an investor is the same as the cost to the company We need to earn at least the required return to compensate our investors for the financing they have provided The required return is the same as the cost of capital and is used as a discount rate Cost of capital and risk: The return required on assets depends on the risk of those assets Thus, our cost of capital provides us with an indication of how the market views the risk of our assets
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3 Cost of Equity The cost of equity is the return required by equity investors given the risk of the cash flows from the firm’s equity There are two major methods for determining the cost of equity Dividend growth model – Already discussed in Chapter 7 SML or CAPM For the dividend growth model approach, recall that: Start with the dividend growth model formula and rearrange to solve for R E g P D R g R D P E E + = - = 0 1 1 0
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4 The SML Approach Use the following information to compute our cost of equity – Risk-free rate, R f – Market risk premium, E(R
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chapter12a - Chapter 12: Cost of Capital Know how to...

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