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Cost of Capital
Cost of Capital
What is capital?
Ex. 5%
After-tax Cost of Debt
rd (1 - t)
rd (1 - t) = 0.05(1-0.40)
=0.05(0.6)
=0.03 / 3%
Cost of Preferred Stock
Dp
rp =
Pp
Dd preferred dividend
rp = Dp / Pp
= $1.25 / $20
= 0.0625 / 6.25%
What is cost of Equity?
Ex. 10%
Methods of estimating the cost of equity
Ke = RF + b (RM RF)
where
b is the return sensitivity of stock to changes in the market return
RM is the expected return on the market
Rf risk-free rate
RM RF is the expected market risk premium or risk premium
Dividend Discount Model
DDM assumes that the value of a stock today is the present value of all future dividends,
discounted at the required rate of return.
re = D1 + g
P0
re = D1 + g
P0