Imrul Kayas, ACA (Mobile No : 01737231658)

Faculty Teacher, Creative Professional Coaching

Formulas of Cost of Capital
Cost of equity
i) Dividend valuation/discount model
Present value of a perpetual method
Do
Ke = [If dividend remains constant]
Po
Present value of a growing perpetual method
Do( 1+ g)
ke = +g [ If dividend grows constantly]
Po
Here, ke = Cost of equity, Do = current year dividend, Po = Current market share price [i.e. ex-dividend share price]
g = growth rate of Dividend (2way to measure),
Do
 ( )
Historical Pattern g = Dividend n year ago 1/n−1

 Gordon Growth Model/ Earning retention model g = rb (Here, r = return on equity & b = retention rate)
**Ex dividend share price = cum dividend share price – dividend amount

ii) Capital Asset Pricing Model

Ke = Rf + β (Rm - Rf)
Here, Rf = risk free rate of return
β = systematic risk/ market risk
Rm = market rate of return
Rm-Rf = market risk premium

iii) Bond yield/return plus risk premium model

Ke = bond yield + risk premium

Cost of Irredeemable preference share

i) Cost of Irredeemable preference share

Do
Kp= [f= floatation cost/ issue cost)
Po−f
[Same formula as kp, if there is any floatation cost; it will be deducted from Po.

Cost of Debt
There are two methods to calculate cost of debt
1. Yield to maturity approach – follow --------IRR Method
2. Debt rating approach -if the market YTM is not available because the firm’s debt is not publicly traded, the
analyst may use the rating and maturity of the firm’s existing debt to estimate the before tax cost of debt. If, for
example, the firm’s debt carries a single- A rated debt to determine the current market rate for debt with a 15-year
maturity. This approach is an example of matrix pricing or valuing a bond based on the yields of comparable
bonds. For example, a similar A rating bond with 5 years maturity gives 10% return. Company’s tax rate is 30%.
Therefore, Kd= I (1-t) = 10%(1-0.30) = 7%

ii) Cost of redeemable preference share/ cost of bond/ debenture

1
 RV −MV /NRV
I ( 1−T ) +
N
Kd = or, IRR method
RV + MV
2
I= Interest rate
T= Tax rate
RV= Redeemable value
MV= Market value
Or, NRV= Net realizable value
N= Number of period

iii) Cost of bank loan

KL= I (1-T)
Cost of capital/ Marginal Cost of capital / WACC =Wdkd(1-t)×Weke×Wpkp
Or,
MVe × ke+ MVd ×kd MVe × ke+ MVd ×kd + MVl ×kl
Cost of capital = or, (including Bank loan)
MVe + MVd MVe + MVd + MVl

MVe = Market value of equity

MVd = Market value of debt
MVl = Market Value of loan
ke = Cost of equity
kd = Cost of debt
kl = Cost of loan
Wd = Weight of Debt
We = Weight of Equity
Wp = weight of Preference Share