Topic 8 Flashcards
The following all mean the same thing:
- Required return
- __________
- Cost of capital
Appropriate discount rate
The cost of capital depends primarily on the use of the funds, not the _________.
source
Advantages and disadvantages of the approach Dividend Model
Advantages are to be easy to understand, and easy to use
Disadvantages: company has to pay dividends, cost of equity is very ________ to the estimated growth rate
sensitive
Advantages and disadvantages of the approach SML
Two advantages: first, it explicitly adjusts for risk. Second, it is applicable to companies other than just those with steady dividend growth
Drawbacks: The SML approach requires that two things be estimated, the ________ and the beta coefficient. To the extent that our estimates are poor, the resulting cost of equity will be inaccurate.
Moreover, as with the dividend growth model, we essentially rely on the past to predict the future when we use the SML approach. Economic conditions can change very quickly, so, as always, the past may not be a good guide to the future.
market risk premium
According to the ________ dividend growth model:
Re = D1/ P + g
where: Re = the required return on shares
constant
Dividend Growth Model Approach
+ Advantages
- Easy to use - Easy to understand
+ Disadvantages
- Only applicable to companies paying dividends
- Assumes dividend growth is \_\_\_\_\_\_.
- Cost of equity is very sensitive to growth estimate.
- Ignores risk.
constant
The SML Approach
+ Advantages
- Adjusts for risk - Accounts for companies that don’t have a constant dividend
+ Disadvantages
- Requires estimate of \_\_\_\_\_
- Uses the past to predict the future
Beta
