Module 11: The Cost of Capital

Question 1

From a ________ perspective, we want to think → What are the sources of capital?

Answer 1

corporate

Question 2

What are the sources of capital (how companies finance operations)? (Two main ones; one extra)

Answer 2

1. Equity
2. Debt
3. Preferred Stock (like a hybrid between debt and equity)

Question 3

When thinking about cost of capital, we want to think about what kind of returns are the _______ investors expecting to get when they give that capital to the firm, what kind of returns are the _______ expecting to get, and then we can average these together to figure out overall, what the _______ is ________ from this firm.

Answer 3

equity; debt-holders; market; demanding

Question 4

reflects the investment opportunities and alternatives in the financial market available to supplier’s of the firm’s capital.

Answer 4

cost of capital

Question 5

Does the CAPM theory and beta have to do with equity or debt?

Answer 5

equity (stockholders)

Question 6

Which does this pertain to, debt or equity?
they have promised cash flows, but they have to worry about not getting paid back. So, if a company has steadier cash flows (ex: grocery stores), the ______ may be a bit safer.

Answer 6

debt

Question 7

As debt increases, the riskiness of getting paid back or not (increases/decreases)

Answer 7

increases

Question 8

Who demands a higher rate of return: debt or equity holders?

Answer 8

debtholders

Question 9

We can look at what the market is demanding from a firm in order to allow them to hold our capital, as a gauge for how _______ the firm is overall.

Answer 9

risky

Question 10

What are the two ways of calculating the cost of equity (calculating the cost of common stock)?

Answer 10

1. Dividend Growth Model
2. The Securities Market Line (and some extensions)

Question 11

How do you calculate the cost of equity (aka the required return on equity, or the cost of equity capital)?

Answer 11

Re = (D1 / P0) + g

Aka cost of equity = (next years dividend / price today) + growth rate

Question 12

Which part of the cost of equity formula is the dividend yield? Which part is the capital gains yield?

Answer 12

Dividend Yield = D1/P0

Capital Gains Yield (how much the price goes up over time) = g