The Cost of Equity is an investment return which a company offers its shareholders in compensation for their income stream and taking risk of investment with a company.
Cost of Equity which is based on the constant dividend growth model is mathematically expressed here.
Cost of Equity = [Dn ÷ P] + G
Dn = dividend per share to be paid next year
P = average stock price in the year the latest dividend paid
G = expected growth of dividend on next year
A next year dividend is mathematically expressed like this.
Dn = Dc × (1 + G)
Dc = dividend per share for present year
Cost of Equity = [Dc × (1 + G)] ÷ P + G
Cost of Debt (COD) is an effective rate that a company will pay on it current debt. The Cost of Debt (COD) can be measured in term before or after tax COD however the after tax Cost of Debt (COD) is often used.
After tax Cost of Debt (COD) is mathematically expressed in the equation below;
Di = individual loan amounts
ri = interest rate of the individual loan
Dt = total loans that a company has
t = company corporate tax rate, %
Note: the interest payment on loans is classified as an operating expense and it is a tax deductible. Continue reading
Every company in any business requires sources of fund to run the business. Two ways that companies can obtain funds are Debt Funding and Equity Funding.
Debt funding is to borrow money from financial instructions and the companies must pay interest and load at some stage depending on payback scheme.
Short term borrowing can come from the following sources;
- commercial paper
Long term borrowing can come from the following sources;
- corporate bonds
- long term loans
Equity often means an ownership interest in a business. The companies sell shares to equity investors as financial institutions, insurance companies, individual investors, etc and these equity investors become the owner of the companies (share holders). The equity investors expect to get regular dividends and a capital gain from the company’s growth. However, there will not guaranteed outcome of the future performance of the company to their share holders. If the company goes bankrupt, the ordinary share holders will be the last group of people who will get the money back. Continue reading