1. Cost of Equity (Ke)

2. Constant growth model
The current market price of a company ‘s share is Rs.90 and the expected dividend per share next year is Rs If the dividends are expected to grow at a constant rate of 8%, Calculate Ke.

3. Ke - g = ------ Po Ke-0.08 = 4.5/90 Ke – 0.08 = 0.05 Ke = 0.05 + 0.08
DIV1
Ke - g = Po
Ke-0.08 = 4.5/90
Ke – 0.08 = 0.05
Ke =
Ke = 0.13
Ke = 13%

4. DIV1
Ke = g Po
= (4.50/90) + .08 =
=.13
=13%

5. Constant growth model
The current market price of a company ‘s share is Rs.83 and the Current year dividend is Rs If the dividends are expected to grow at a constant rate of 9%, Calculate Ke.

6. Assume that a company’s share is currently selling for Rs. 134
Assume that a company’s share is currently selling for Rs.134. current dividends DIV0 are Rs.3.50 per share and are expected to grow at 15%over the next 6 years and at a rate of 8% forever. Calculate Ke.

7. YEAR
DIVIDEND
@10%
@12%
12% 1
3.50*1.15=4.03
.909
3.66
.893
3.598 2
4.03*1.15=4.63
.826
3.82
.797
3.690 3
4.63*1.15=5.33
.751
4.00
.712
3.795 4
5.33*1.15=6.13
.683
4.19
.636
3.899 5
6.13*1.15=7.05
.621
4.38
.567
3.997 6
7.05*1.15=8.11
.564
4.57
.507
4.112 7
8.11*1.08=8.76
Total PV for 6 years
24.62
23.091

8. 8.76
= (0.564) = =
= (0.507) = =

9. Cost of Equity Capital
Cost of External Equity: The Dividend—Growth Model
Earnings–Price Ratio and the Cost of Equity

10. The Capital Asset Pricing Model (CAPM)
As per the CAPM, the required rate of return on equity is given by the following relationship:
Equation requires the following three parameters to estimate a firm’s cost of equity:
The risk-free rate (Rf)
The market risk premium (Rm – Rf)
The beta of the firm’s share ()

11. CAPM Problems
Calculate Ke using CAPM approach, the risk free rate of return equals 10%, the firm’s Beta equals 1.50 and the return on the market portfolio equals 12.5%.

12. Ke = 10% + 1.5(12.5%-10%) = 13.75%

13. As a investment manager you are given the following information
As a investment manager you are given the following information. Risk free return 14%
Investment
Initial price
Dividends
Year end price
Beta risk factor
Cement Ltd 25 2 50
.80
Steel Ltd 35 60
.70
IT Ltd 45
135
.50
Govt. of India Bonds
1000
140
1005
.99

14. Expected return on market portfolio
security
Return 1
Dividend
Return 2
Capital appreciation
Total
Investment
Cement Ltd
Steel Ltd
IT Ltd
Govt. of India Bonds
Rate of return on market portfolio

15. Expected return on market portfolio
security
Return 1
Dividend
Return 2
Capital appreciation
Total
Investment
Cement Ltd 2 25 27
Steel Ltd 35
IT Ltd 90 92 45
Govt. of India Bonds
140 5
145
1000
291
1,105
Rate of return on market portfolio =(291/1105)* 100
= 26.33%

16. Expected return on Individual security
Ke= Rf + ƅ(Rm-Rf) Ke
Cement Ltd
14% +.8 ( 26.33%-14%)
23.86%
Steel Ltd
IT Ltd
Govt. of India Bonds

17. Expected return on Individual security
Ke= Rf b(Km-Rf) Ke
Cement Ltd
14% +.08 ( 26.33%-14%)
23.86%
Steel Ltd
14% +.7( 26.33%-14%)
22.63%
IT Ltd
14% +.5( 26.33%-14%)
20.16%
Govt. of India Bonds
14% +.99( 26.33%-14%)
26.21%

18. Cost of Retained Earnings
If earnings are not retained, it would have been paid out to the ordinary shareholders as dividend.
If earnings are retined, forced to forego dividends
Thus it involve opportunity cost.
Kr likely to be equal Ke.

19. Overall cost of capital
Book Value weights:
A firm’s after tax cost of capital of the specific sources is as follows: Calculate Ko
Capital stucture
cost
amount
Debt 8%
3,00,000
Preference
14%
2,00,000
Equity
17%
5,00,000

20. Ko (Book Value) Fund Amount cost Debt 3,00,000 8%= 24,000 Preference
2,00,000
14%= 28,000
Equity
5,00,000
17%= 85,000
1,37,000
1,37,000
Ko = *100
10,00,000
13.7%

21. Ko- Market Value Source Specific Cost Market Value Book Value Debt 8%
2,70,000
3,00,000
Preference
14%
2,30,000
2,00,000
Equity & Retained earnings
17%
7,50,000
5,00,000

22. Find out the market value for retained earnings
7,50,000-5,00,000
= * 100
12,50,000
= 20%
Retained Earnings = 7,50,000*20/100
= 1,50,000

23. Computation of Ko (Market Value Weights)
Sources
Market Value
Cost%
Total cost
Debt
2,70,000 8
21,600
Preference
2,30,000 14
32,200
Equity
6,00,000 17
102000
Retained earnings
1,50,000
25,500
12,50,000
1,81,300
1,81,300
Ko = *100
12,50,000
= 14.5%

24. Overall cost of capital
Book Value weights:
A firm’s after tax cost of capital of the specific sources is as follows: Calculate Ko
Capital stucture
cost
amount
Debt 6%
4,00,000
Preference
10%
2,00,000
Equity
13%