Cost of Debt

Bond Yield + Risk Premium Approach Formula kCE Suppose
Bond Yield Risk Premium 8% 5%

=

bond yield + Risk Premium Approach

Solution kCE = 8%+5%=13%

Capital Asset Pricing model approach (CAPAM)
RFR β E(Rmkt) Risk Free Rate Estimated Stock Beta Estimated expected rate of return

Formula

kCE=RFR+β[E(Rm)-RFR] =
Suppose
RFR Rm β = = = 6% 11% 1.1%

Solution kCE = 6%+1.1(11%-6%)=11.5%

Cost of Debt
Interest rate 8% Tax Rate 40% What is cost of debt Capital

Formula kd(1-t) = 8%(1-0.4)=4.8%

Cost of Preferred Stock
Dividend per share $8 Market Price of Preferred of Stock $100

kps=$8/$100=0.08 or 8%

Dividend Discount Model (DDM)
D1 Kce g Next year dividend Required rate of return of Common Equity The firms's expected constant growth rate

Formula kCE=D1/P0+g =

g=(ROE)(retention rate)
Question ROE 12% Retention Rate =

(1-Payout ratio) (1-0.4)

Solution
g =(0.12)(1-0.4)=0.072=7.2% (1/21)+0.072=0.12 or 12%

kCE=D1/P0+g

Equity wth rate