Cost of Capital Flashcards
(24 cards)
How do you reach a suitable discount rate?
Calculate the cost of each source of long term finance separately and the combine them to get WACC.
D0=
dividend just paid.
P0=
ex-div market share price.
g=
growth.
Rf=
risk free rate.
Rm=
average market return.
β=
beta factor.
How do you calculate Kp?
D/P0
D=
constant dividend.
How do you calculate Kd?
Yield(1-T)
How do you calculate yield? Redeem/Irredeem
IRR with 2 DFs or I/P0
T=
corporation tax rate.
I=
interest paid.
What 5 assumptions are made when using the DVM model?
- Perfect markets.
- All investors have the same expectations.
- Constant growth in dividends.
- Interim dividends ignored.
- Personal tax issues ignored.
Name 2 issues with Ke.
- Share prices change so P0 can be inaccurate.
- Difficult to predict growth.
What should you do if gearing isn’t constant?
Use APV.
What should you do if business risk isn’t constant?
Use CAPM to generate Ke.
What is the Gordon Growth Model?
g=r(accounting rate of return on new investment) x b(earnings retention rate)
What are the 5 limitations of the Gordon growth model?
- Relies on accounting profits.
- Assumes b and r are constant.
- Can be distorted by inflation.
- Relies on historic information.
- Assumes all new finance is from equity and gearing is constant.
Market Premium=
(Rm-Rf)
Dividend in 2016 was £10 and in 2020 it was £20. How do you calculate the average growth?
(20/10)^(1/4) - 1
How do you calculate “r” (accounting rate of return on new investment)?
Earnings/(£1/50p ordinary share capital+RE at the start of the year)
How do you calculate “b” (earnings retention rate)?
(Earnings-Dividend paid)/Earnings
Should you include a “Special Dividend” when calculating the DVM, and why?
No, as it’s a one off. STATE THIS.
