Chapter 9 - Cost of capital

Question 1

What is Ke in the divident growth model?

Answer 1

Cost of Equity

Question 2

What is d0 in the Dividend Valuation/Growth Model?

Answer 2

Current dividend

Question 3

What is g in the Dividend Valuation/Growth Model?

Answer 3

Expected future growth of dividends

Question 4

What is P0 in the Dividend Valuation/Growth Model?

Answer 4

Current market price (ex-div)

Question 5

What are four weaknesses with the Dividend Valuation/Growth Model?

Answer 5

▪ The model does not incorporate risk

▪ It assumes that dividends grow at a constant rate

▪ Future dividend growth is predicted from past results

▪ Share price may fluctuate

Question 6

What is re (return on invested funds)?

Answer 6

(PAT - Pref dividends) ÷ (capital employed or shareholder funds)

Question 7

What is b (proportion of earnings retained)?

Answer 7

(Profit retained) ÷ (PAT)

Question 8

What is the formula for cost of preference shares (irredeemable)?

Answer 8

K(pref)=d/P0

Question 9

What are the four main types of debt?

Answer 9

• Irredeemable
• Redeemable
• Convertible
• Bank loan

Question 10

Cost of irredeemable debt

Answer 10

𝑘𝑑 = (i *(1 − 𝑡)) /𝑃0

kd = Cost of debt

i = Annual interest (£)

t = Corporate tax rate

P0 = Current market price of debt (ex-int)