Cost of Capital

Flashcards about the cost of capital.

Creditors

Capital: Long-term debt

Cost of Capital: After-tax rate of interest

Preferred stockholders

Capital: Preferred stock

Cost of Capital: Preferred dividends per share / Current market price or Net issuance price

Common stockholders

Capital: Common stock

Cost of Capital: CAPM or DDM

CAPITAL ASSET PRICING MODEL (CAPM)

R = R_F + β(R_M – R_F)

where:

R = rate of return

R_F = risk-free rate determined by government securities

β = beta coefficient of an individual stock which is the correlation between the volatility (price variation) of the stock market and the volatility of the price of the individual stock.

Cost of Retained Earnings

(D₁ / P₀ ) + G

where:

P₀ = current price

D₁ = next dividend

G = growth rate in dividends per share (it is assumed that the dividend payout ratio, retention rate, and therefore the EPS growth rate are constant)

Cost of New Common Stock

D₁ / P₀ (1 – Flotation Cost) + G

Flotation Cost

the cost of issuing new securities

TYPES OF THE DIVIDEND DISCOUNT MODEL (OR DIVIDEND GROWTH MODEL)

• Cost of Retained Earnings

• Cost of New Common Stock