Cost of Capital (2) Flashcards
Assumption for DVM (investors)
All investors have the same expectations and therefore the same required rate of return.
Assumption for DVM (capital market)
Rational investors
No taxes or transaction costs
Perfect information is freely available to all investors
Assumption for DVM (dividend paid)
Dividends are paid just once a year and one year apart
Assumption for DVM (constant)
Dividends are either constant or are growing at a constant rate
Advantages of a DVM?
It is easy to understand and can be applied to any share that offers a dividend
There is no ambiguity in determining amounts of dividends
Minority shareholders who have no control over a company’s policies
Disadvantages of a DVM?
Assumes shares have no issue costs, incorporate risk
It makes no allowance for the effect of taxation
Ignores capital gains tax on investors
What is ex-div market value?
Market value of the share, assuming that the current dividend has just been paid
What is a cum-div market value?
One which includes the value of the dividend just about to be paid
If given a cum-div market value, what is the calculation?
This must be adjusted to an ex-div market value by deducting the current dividend
Two methods for the growth rate of dividends?
Extrapolation of past dividends
Gordon’s growth model
What is the extrapolation of past dividends?
This method analyses historical growth to predict future growth
What if dividends have grown at 5% each year for the last 10 years?
Predicted future growth is 5%
What is a loan note?
A security instrument (so it is tradable) that acknowledges a company’s debt.
Characteristics of a loan note?
Usually pays a fixed coupon
May be secured or unsecured
If quoted, it will trade on an exchange at a price determined by that market
What is coupon rate?
The interest rate printed on the loan note certificate.
