Cost of Capital 1. 2. 3. 4. What are the 2 main methods for determining the Cost
ID: 2799978 • Letter: C
Question
Cost of Capital 1. 2. 3. 4. What are the 2 main methods for determining the Cost of equity? How can one find the before tax cost of debt? Which cost used in the Weighted Average Cost of Capital needs to be multiplied by (1-T)? When calculating WACC, which capital is excluded and why? Stocks What is the preemptive right associated with a stock? What is the role of the stockholders, board of directors, and the management team in corporate governance? What are two models used by financial analysts to estimate the price of a stock? Is there any condition which renders the dividend discount model useless? In what sense is preferred stock "preferred" over common stock? What do common shareholders get in addition to possible dividends? 1. 2. 3. 4. 5. 6.Explanation / Answer
Q1
a) Dividend growth model:
Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate
b)Capital Asset Pricing Model (CAPM):
Cost of equity= Risk free rate+ Beta *(Expected market return- risk free rate)
Q2 Cost of debt is usually based on bonds issued by the company. The coupon rate of bond issued is treated as cost of debt for bonds issued at par value.
Q3 Cost of debt need to be multiplied by (1- T) to find out after tax cost of debt. After tax cost of debt is used for WACC calculation.
Q4 Accounts payable is excluded while calculating WACC as no opprtunity cost is incurred. Also, WACC includes all item that comes form investors.