Cost of Capital Flashcards
1
Q
Explain the formula for the cost of equity using CAPM: Ri = Rf +Bi(Rm-Rf)
A
- Rf = Risk free rate (govt bond)
- Bi = Stock Beta (market sensitivity)
- Rm-Rf = Market risk premium
2
Q
Assumptions of CAPM?
A
- Beta remains stable
- Market returns are normally distributed
- Investors are rational
3
Q
Explain the formula for cost of equity using DGM: ke = (D1/ P0) + g
A
- D1 = Next year dividend
- P0 = Current stock price
- G = Dividend Growth Rate
4
Q
What is the difference between systematic and unsystematic risk?
A
Systematic risk affects the entire market and is non-diversifiable, while unsystematic risk is specific to a company and can be diversified away.
5
Q
Explain the formula for calculating the cost of an irredeemable Bond: i = C/ P
A
- C = Coupon Payment
- P = Bond price
6
Q
Explain the formula for calculating the valuation of a redeemable bond: P = SGMA (C/ 1+i)^n) + R/ (1+i)^n
A
- P = Bond Price
- C = The coupon
- R = Redemption value
- n = Years to maturity
7
Q
Explain the formula for cost of Preference Shares: i = D/ P
A
- D = Fixed dividend
- P = Market Price
8
Q
What does Beta measure in CAPM?
A
Beta measures a stock’s sensitivity to market movements, indicating its level of systematic risk.
9
Q
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