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FM Irc Sources of Fin Wacc
FM Irc Sources of Fin Wacc
Advantages Disadvantages
Comparison
Islamic finance
Dividend policy
2.
generally Will fall
More number
shares issued and
Issue the RI disocunted
price ...discounted price
TERP
Cum or Ex rights
price VALUE of RIGHT
VALUE od RIGHT
per EXISTING
SHARE
Cost of preference
Kp= D/Po
Debt
Debt
Preference
Equity
0 Market price DO two PV @ 5% and 10%
n Redemption value or
Conversion value
IRR
Column A B C D E F
Row 2 -120 5.25 5.25 5.25 5.25 135.25
=IRR(A2:f2)
COST OF CAPITAL
COST OF EQUITY
DIVIDEND
CONSTANT
GROWTH
DIV model ?
model ? g
CAPM ?
beta β
i. Dividend growth model (DVM) for Ke
ii. CAPM
The risk a shareholder faces is in large part due to the volatility of the company’s earnings. This
volatility can occur because of:
(a) Systematic (or market) risk – it is the risk of market wide factors such as the state of
economy. It will affect all companies in the same way (although to varying degrees), and
it cannot be diversified away.
(b) Non-systematic (or unsystematic or business or unique) risk – it is the risk factors
will impact each firm differently, depending on their circumstances. Diversification can
almost eliminate unsystematic risk.
Beta Factor
The CAPM is mainly concerned with how systematic risk is measured, and how systematic
risk affects required return and share prices. Systematic risk is measured using beta
factors.
(b) Beta factor is the measure of the systematic risk of a security relative to the market
portfolio (e.g. Heng Seng Index). If a share price were to rise or fall at double the market
rate, it would have a beta factor of 2.0. Conversely, if the share price moved at half the
market rate, the beta factor would be 0.5.
(c) Beta = 1, a 1% change in the market index return generally leads to a 1% change in the
return on a specific share.
0 < Beta < 1, a 1% change in the market index return generally leads to a less than a 1%
change in the returns on a specific share.Beta > 1, a 1% change in the market index
return generally leads to a greater than 1% on a specific company’s share.
Assumptions of CAPM
Well-diversified investors
(e) All forecasts are made in the context of one time period only.
Problems of CAPM include unrealistic assumptions and the required estimates being
difficult to make.
(a) The need to determine the excess return (Rm - Rf). Expected, rather than
historical, returns should be used, although historical returns are often used in practice.
(b) The need to determine the risk-free rate. A risk-free investment might be a
government security. However, interest rates vary with the term of the lending.
(c) Errors in the statistical analysis used to calculate beta values. Betas may also
change over time.
(d) The CAPM is also unable to forecast accurately returns for companies with
low price/earnings ratios and to take account of seasonal “month-of-the-
year” effects and “day-of-the-week” effects that appear to influence returns on
shares.
a) For DVM:
(i) Estimate the future dividend and growth rate are difficult to do.
(ii) Assume the business risk, and hence business operations and the cost of equity,
are constant in future periods.
(iii) Do not consider risk – it should be noted that share price fall as risk increases,
indicating that increasing risk will lead to an increasing cost of equity.
(ii) Give rise to a much smaller degree of uncertainty than the future dividend
growth in the DVM.