Cost of Capital

Vocabulary flashcards related to the cost of capital, as covered in the FINANCE FIN537 lecture.

Cost of Equity

The return required by equity investors given the risk of the cash flows from the firm.

Dividend Growth Model Approach

A method for estimating the cost of equity using the formula: RE = g + (D1 / P0).

SML Approach

A method for estimating the cost of equity using the formula: RE = Rf + Be (E(RM) – Rf).

Cost of Debt

The required return on a company’s debt, best estimated by computing the yield-to-maturity on existing debt.

Cost of Preferred Stock

A constant dividend paid each period, calculated as RP = D / P0

Weighted Average Cost of Capital (WACC)

The 'average' cost of capital for the firm, which is the required return on the firm’s assets based on the market’s perception of the risk of those assets.

E

The market value of equity, calculated as the number of outstanding shares times the price per share.

D

The market value of debt, calculated as the number of outstanding bonds times the bond price.

V

The market value of the firm, calculated as the sum of the market value of debt and the market value of equity (D + E).

wE

The proportion of financing that comes from equity, calculated as E/V.

wD

The proportion of financing that comes from debt, calculated as D/V.

Flotation Costs

Expenses such as underwriting fees, legal fees, and registration fees, incurred when a publicly traded company issues new securities.

Pure Play Approach

An approach that seeks to identify companies specializing in the same product or service as the project under consideration to compute an appropriate beta.

Subjective Approach

An approach that adjusts the discount rate based on the project’s risk relative to the firm overall.