Cost of Equity

Economics of new nuclear power plants - Capital costs 1 Some analysts argue (for example Steve Thomas, Professor of Energy Studies at the University of Greenwich in the UK, quoted in the book The Doomsday Machine (2012 book)|The Doomsday Machine by Martin Cohen and Andrew McKillop ]) that what is often not appreciated in debates about the economics of nuclear power is that the cost of equity, that is companies using their own money to pay for new plants, is generally higher than the cost of debt.The Doomsday Machine, Cohen and McKillop (Palgrave 2012) page 199 Another advantage of borrowing may be that once large loans have been arranged at low interest rates - perhaps with government support - the money can then be lent out at higher rates of return.

Corporate finance - Capitalization structure 1 The cost of equity (see Capital asset pricing model|CAPM and arbitrage pricing theory|APT) is also typically higher than the cost of debt - which is, additionally, a deductible expense – and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.See:[ Balance-of-Financial-Instruments-Long-Term- Management-Market-Volatility-Proposed- Changes-3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed Changes], Nishant Choudhary, LL.M

Capital asset pricing model 1 CAPM “suggests that an investor’s cost of equity capital is determined by beta.”

Business valuation - Modified Capital Asset Pricing Model 1 The Cost of Equity (Ke) is computed by using the Modified Capital Asset Pricing Model (Mod. CAPM)

Business valuation - Build-Up Method 1 Total Cost of Equity (TCOE) = risk-free rate + total beta*equity risk premium

Business valuation - Build-Up Method 1 While it is possible to isolate the company- specific risk premium as shown above, many appraisers just key in on the total cost of equity (TCOE) provided by the following equation: TCOE = risk-free rate + Total beta*equity risk premium.

Modigliani-Miller theorem - Proposition II 1 * r_E is the required rate of return on equity, or cost of equity.

Modigliani-Miller theorem - Proposition II 1 * r_0 is the company cost of equity capital with no leverage (unlevered cost of equity, or return on assets with D/E = 0).

Modigliani-Miller theorem - Proposition II 1 The same relationship as earlier described stating that the cost of equity rises with leverage, because the risk to equity rises, still holds

Working capital management - Capitalization structure 1 The cost of equity (see Capital asset pricing model|CAPM and arbitrage pricing theory|APT) is also typically higher than the cost of debt - which is, additionally, a deductible expense – and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.See:[ Optimal-Balance-of-Financial-Instruments-Long- Term-Management-Market-Volatility-Proposed- Changes-3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed Changes], Nishant Choudhary, LL.M

Time value of money - Calculations 1 The rate of return in the calculations can be either the variable solved for, or a predefined variable that measures a discount rate, interest, inflation, rate of return, cost of equity, cost of debt or any number of other analogous concepts. The choice of the appropriate rate is critical to the exercise, and the use of an incorrect discount rate will make the results meaningless.

Capital structure - Capital structure in a perfect market 1 Their second 'proposition' stated that the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm, plus an added premium for financial risk

Working capital management - Capitalization structure 1 The cost of equity (see Capital asset pricing model|CAPM and arbitrage pricing theory|APT) is also typically higher than the cost of debt - which is, additionally, a deductible expense – and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.See:[ Optimal-Balance-of-Financial-Instruments-Long- Term-Management-Market-Volatility-Proposed- Changes-3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed Changes], Nishant Choudhary, LL.M

Residual income valuation 1 'Residual income valuation' (RIV; also, residual income model and residual income method, RIM) is an approach to equity valuation that formally accounts for the cost of equity capital

Residual income valuation - Concept 1 This rate of return is the cost of equity, and a formal equity cost must be subtracted from net income

Residual income valuation - Calculation of residual income 1 The cost of equity is typically calculated using the Capital Asset Pricing Model|CAPM, although other approaches such as arbitrage pricing theory|APT are also used. The currency charge to be subtracted is then simply

Residual income valuation - Calculation of residual income 1 :Equity Charge = Equity Capital x Cost of Equity,

Residual income valuation - Valuation formula 1 Using the residual income approach, the company valuation|value of a company's stock can be calculated as the sum of its book value and the present value of its expected future residual income, discounted at the cost of equity, r, resulting in the general formula:

Residual income valuation - Comparison with other valuation methods 1 As can be seen, the residual income valuation formula is similar to the dividend discount model (DDM) (and to other discounted cash flow (DCF) valuation models), substituting future residual earnings for dividend (or free cash) payments (and the cost of equity for the weighted average cost of capital).

Adjusted present value 1 Technically, an APV valuation model looks similar to a standard Discounted cash flow|DCF model. However, instead of weighted average cost of capital|WACC, cash flows would be discounted at the unlevered cost of equity, and tax shields at either the cost of debt (Myers) or following later academics also with the unlevered cost of equity E.pdf

Cost of capital - Summary 1 A company's securities typically include both debt and equity, one must therefore calculate both the cost of debt and the cost of equity to determine a company's cost of capital

Cost of capital - Summary 1 The cost of equity is therefore inferred by comparing the investment to other investments (comparable) with similar risk profiles to determine the market cost of equity

Cost of capital - Summary 1 Once cost of debt and cost of equity have been determined, their blend, the weighted-average cost of capital (WACC), can be calculated. This WACC can then be used as a Annual effective discount rate|discount rate for a project's projected cash flows.

Cost of capital - Cost of debt 1 Since in most cases debt expense is a deductible expense, the cost of debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are After Taxes|after-tax as well)

Cost of capital - Cost of equity 1 Cost of equity = Risk free rate of return + Premium expected for risk

Cost of capital - Cost of equity 1 Cost of equity = Risk free rate of return + Beta x (market rate of return- risk free rate of return)

Dividend discount model 1 The variables are: P is the current stock price. g is the constant growth rate in perpetuity expected for the dividends. r is the constant cost of equity capital for that company. D_1 is the value of the next year's dividends.

Dividend discount model - Derivation of equation 1 : P = \frac \times(1+g)(1+r)D_0(1+g)IncomeCapital GainTotal ReturnDividend YieldGrowthCost Of EquityDPDPDr -gD_0 \left( 1+g \right)^t\left( 1+r\right)^tP_N\left( 1 +r\right)^ND_0 \left( 1 + g \right)\left( 1+g \right)^N\left( 1 + r \right)^ND_0 \left( 1 + g \right)^N \left( 1 + g_\infty \right)\left( 1 + r \right)^N \left( r - g_\infty \right)rP_0 + g.

Uwe Reinhardt - Research 1 Reinhardt's previous work on hospitals examined the tax advantage|tax and cost of capital|cost of equity capital advantages of non-profit hospital|not-for-profit hospitals over for-profit hospitals.

Tax benefits of debt 1 For example, some critics have argued that the cost of equity should also be deductible; which could reduce the Internal Revenue Code's influence on capital- structure decisions, potentially reducing the economic instability attributable to excessive debt financing.

Growth and yield modelling 1 'Growth and yield model is a branch of the subject financial management. this method is also known as gordon constant growth model. in this method the cost of equity share capital by determining the sum of yield percentage and growth percentage..

Cost of debt - Cost of debt 1 Since in most cases debt expense is a deductible expense, the cost of debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are after-tax as well)

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