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    Cost of Common Stock: FERNANDO, Clarence P. Bsa - 3A

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    Jerome Montoya
    This document discusses the cost of common stock and two forms of common stock financing - retained earnings/internal equity and new issues of common stock/external equity. It provides examples of how to calculate the cost of common stock using the constant growth valuation model and CAPM. It also provides an example of how to calculate the cost of a new issue of common stock by taking into account underpricing and flotation costs.

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    Cost of Common Stock: FERNANDO, Clarence P. Bsa - 3A

    Uploaded by

    Jerome Montoya
    26 views17 pages
    This document discusses the cost of common stock and two forms of common stock financing - retained earnings/internal equity and new issues of common stock/external equity. It provides examples of how to calculate the cost of common stock using the constant growth valuation model and CAPM. It also provides an example of how to calculate the cost of a new issue of common stock by taking into account underpricing and flotation costs.

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    3. Clarence Fernando

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    This document discusses the cost of common stock and two forms of common stock financing - retained earnings/internal equity and new issues of common stock/external equity. It provides examples of how to calculate the cost of common stock using the constant growth valuation model and CAPM. It also provides an example of how to calculate the cost of a new issue of common stock by taking into account underpricing and flotation costs.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    26 views17 pages

    Cost of Common Stock: FERNANDO, Clarence P. Bsa - 3A

    Uploaded by

    Jerome Montoya
    This document discusses the cost of common stock and two forms of common stock financing - retained earnings/internal equity and new issues of common stock/external equity. It provides examples of how to calculate the cost of common stock using the constant growth valuation model and CAPM. It also provides an example of how to calculate the cost of a new issue of common stock by taking into account underpricing and flotation costs.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 17

    COST OF

    COMMON STOCK
    FERNANDO, Clarence P.
    BSA 3A
    TWO FORMS OF COMMON
    STOCK FINANCING
    1) Retained Earnings/ Internal
    Common Equity
    2) New issues of common stock/
    External Common Equity
    COST OF
    COMMON STOCK
    The return that investors
    holding shares in a firm
    require.
    Finding the Cost of
    Common Stock Equity
    Constant-growth valuation
    (Gordon Growth) model
    Capital asset pricing model
    (CAPM)
    Finding the Cost of Common Stock
    Equity: Using the Constant-growth
    valuation (Gordon Growth) model
    Per-share dividend
    Value of Assumes that dividends expected at the
    end of year 1
    Common stock will grow at a constant
    rate.

    Required return Constant rate of


    on common stock growth in dividends
    Example
    ABC Corporation wishes to determine its cost of common stock equity.
    The market price of its common stock is 50 per share. The firm expects
    to pay a dividend of 4 at the end of the coming year and the annual
    growth rate of dividends is 5%. Calculate the required rate of return.

    = 4 = 5% =50 =?

    rs = 4
    50 + 0.05

    rs = 13%
    Finding the Cost of Common Stock Equity:
    Using the Capital Asset Pricing Model
    (CAPM) Market risk premium

    Describes the relationship


    between the required return and
    the non-diversifiable risk of the
    firm.
    required risk-free rate beta market
    return of return coefficient return
    Example
    ABC Corporation now wishes to calculate its cost of
    common stock equity by using the CAPM. The firms beta
    equals 1.5, the risk-free rate equals 7% and the market
    return equals 11%.
    = 1.5 = 7% = 11% =?

    rs =7% +[1.5(11% 7%)]


    =7% + 6%
    rs = 13%
    Two Forms Of
    Common Stock
    Financing
    Two Forms Of Common Stock Financing:
    The Cost Of Retained Earnings

    Cost of retained earnings is the


    same as the cost of an equivalent
    fully subscribed issue of
    additional shares.
    ABC Corporation

    = 13%
    Two Forms Of Common Stock
    Financing: The Cost Of New issues of
    common stock

    The cost of a new issue of common stock is


    determined by calculating the cost of common
    stock, net of underpricing and associated
    flotation costs.
    Two Forms Of Common Stock
    Financing: The Cost Of New issues of
    common stock
    Expected dividend

    Cost of a
    new issue Expected
    of common growth rate
    stock of dividends

    Net proceeds from the sale of common


    stock after underpricing and flotation
    costs
    Example
    To determine its cost of new common stock, rn, ABC
    Corporation has estimate that on average, new shares can
    be sold for 47. The 3 per-share underpricing is due to the
    competitive nature of the market. A second cost associated
    with a new issue is flotation costs of 2.50 per share that
    would be paid to issue and sell the new shares. The total
    underpricing and flotation cost per share are therefore 5.50.
    (3 + 2.50) Subtracting the 5.50 per share underpricing and
    flotation cost from the current 50 share price results in
    expected net proceeds of 44.50 per share.
    =4 = 44.50 = 5% =?

    rn = 4.00
    44.50 + 0.05

    rn = 14%
    rr = 13%

    <
    rn = 14%

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