Chapter+12 - Chapter 12 Cost of Capital Basics Cost of...

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Chapter 12 1 Cost of Capital Basics • The cost to a firm for capital funding = the return to the providers of those funds – The return earned on assets depends on the risk of those assets – A firm’s cost of capital indicates how the market views the risk of the firm’s assets – A firm must earn at least the required return to compensate investors for the financing they have provided – The required return is the same as the appropriate discount rate Cost of Equity • The cost of equity is the return required by equity investors given the risk of the cash flows from the firm • Three major methods for determining the cost of equity –Discount expected dividends and prices - Dividend growth model - SML or CAPM g P D R g R D P 0 1 E E 1 0 ) R ) R ( E ( R R f M E f E Example: Cost of Equity • Data: – Beta = 1.5 – Market risk premium = 9% – Current risk-free rate = 6%. – Analysts’ estimates of growth = 6% per year
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Chapter+12 - Chapter 12 Cost of Capital Basics Cost of...

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