Cost of equity refers to a shareholder's required rate of return on an equity investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. How It Works/Example:

The cost of equity is the rate of return required to persuade an investor to make a given equity investment.

In general, there are two ways to determine cost of equity.

First is the dividend growth model:

Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate

Second is the Capital Asset Pricing Model (CAPM):

ra = rf + Ba (rm-rf)

where:
rf = the rate of return on risk-free securities (typically Treasuries) Ba = the beta of the investment in question
rm = the market's overall expected rate of return

Let's assume the following for Company XYZ:
Next year's dividend: $1
Current stock price: $10
Dividend growth rate: 3%
rf: 3%
Ba: 1.0
rm: 12%

Using the dividend growth model, we can calculate that Company XYZ's cost of capital is ($1 / $10 ) + 3% = 13%

Using CAPM, we can calculate that Company XYZ's cost of capital is 3% + 1.0*(12% - 3%) = 12% Why It Matters:
Cost of equity is a key component of stock valuation. Because an investor expects his or her equity investment to grow by at least the cost of equity, cost of equity can be used as the discount rate used to calculate an equity investment's fair value.

Both cost of equity calculation methods have advantages and disadvantages.

...will receive this report, and based on the findings and analysis included, Apple will be given a recommendation as to the costequity model they should implement to estimate their future rate of returns.
This report will discuss the accuracy and ease of use of these three models. The main consideration will be determined by how realistic each model is at developing the assumed rate of return.
Part 2 of this paper will discuss the cost ofequity or discount rate based on hypothetical data to be calculated using the CAPM model. Considering the information presented, the cost of equity for each company will be explained and what factors influence company beta.
I will explain how to apply dividend growth when estimating the cost of equity of stable companies. I will show my understanding of APT and how it relates to CAPM and dividend growth, while also applying CAPM to estimate the rate of return that a company’s investors require.
In conclusion I will reiterate what I perceive to have learnt as well as give my evaluation of the module 3 case assignment.
Part I
Report to Apple Board of Directors
Apple stock has been extremely stable with a beta of .74 and that number has probably risen in the last six months since Apple stock has gone into a negative trend for the first time in many years. Apple has not held any debt so there is no...

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Equity
In accounting and finance, equity is the residual value or interest of the most junior class of investors in assets, after all liabilities are paid; if liability exceeds assets, negative equity exists. In an accounting context, shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or similar terms) represents the remaining interest in the assets of a company, spread among individual shareholders of common or preferred stock; a negative shareholders' equity is often referred to as a positive shareholders' deficit. At the very start of a business, owners put some funding into the business to finance operations. This creates a liability on the business in the shape of capital as the business is a separate entity from its owners. Businesses can be considered, for accounting purposes, sums of liabilities and assets; this is the accounting equation. After liabilities have been accounted for, the positive remainder is deemed the owners' interest in the business. This definition is helpful in understanding the liquidation process in case of bankruptcy. At first, all the secured creditors are paid against proceeds from assets. Afterwards, a series of creditors, ranked in priority sequence, have the next claim/right on the residual proceeds. Ownership equity is the last or residual claim against assets, paid only after all other creditors...

...1. How are Mortensen’s estimates of Midland’s cost of capital used? How, if at all, should these anticipated uses affect the calculations?
Mortensen’s cost of capital estimates are used for a variety of purposes at both the divisional and corporate levels. Examples include internal analyses such as financial accounting, performance assessment and capital budgeting, while others are used for strategic planning purposes such as merger and acquisition, as well as stock repurchase decisions (Luehrman and Heilprin, 2009, pg.1). When used at the divisional rather than corporate level, special consideration should be given to the fact that Midland’s divisions are not publicly traded entities, and therefore do not have individual Beta figures. In order to properly assess the cost of capital for Midland’s divisions, Mortensen collected beta estimates from several businesses with operations similar to those of Midland’s divisions and used the average of these estimates to derive a beta estimate for divisional beta estimates (pg.6).
2. Calculate Midland’s corporate WACC. Be prepared to defend your specific assumptions about the various inputs to the calculations (risk-free rate, equity market risk premium (EMRP), beta). Is Midland’s choice of EMRP appropriate? If not, what recommendations would you make and why?
Midland’s corporate WACC is 9.17%. Please see exhibit 1 for supporting calculations. The risk-free...

...2. Suppose the market portfolio has an expected return of 10% and a volatility of 20%, while Microsoft’s stock has a volatility of 30%.
A. Given its higher volatility, should we expect Microsoft to have an equitycost of capital that is higher than 10%?
No, Microsoft is diversifiable and it will not be affected by the changes in the market. We do not expect Microsoft’s equitycost of capital to be higher than 10%. Each stock carries its own weight.
B. What would have to be true for Microsoft’s equitycost of capital to be equal to 10%?
In order for Microsoft’s equitycost of capital to be 10% its beta will have to be 1.
4. Suppose all possible investment opportunities in the world are limited to the five stocks listed in the table below. What does the market portfolio consist of (what are the portfolio weights)?
Stock Price/Share ($) Number of Shares Outstanding (millions)
A 10 10
B 20 12
C 8 3
D 50 1
E 45 20
Total value of the market = 10x10+20x12+8x3+50x1+45x20= $1.314 billion
Stock Portfolio Weight
A 10x10=100 100/1314 =0.0761 x 100 = 7.61%...

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Table of Contents
Cost of Capital 2
Value of Equity 2
Cost of Equity 2
CAPM Model 2
Dividend Growth Model 3
Value of Debt 3
Cost of Debt 4
WACC (Weighted Average Cost of Capital) 4
Comparison to Joanna Cohen’s Analysis 4
Financial Statement Analysis 5
Nike Inc. 5
Financial Ratios 6
Leverage Ratios 6
Efficiency Ratios 6
Liquidity Ratios 7
Profitability Ratios 7
Valuation Ratios 7
Conclusion 8
Appendix A – Ratio Calculation 9
Leverage Ratios 9
Efficiency Ratios 9
Liquidity Ratios 9
Profitability Ratios 10
Valuation Ratios 10
Cost of Capital
Value of Equity
Cohen's calculation considered the book values to calculate the proportion of equity for calculating the value of WACC which should only be done if the target or market values are not available. In order to determine a more realistic cost of equity, it is recommended to use the market value. The current market share price of Nike as of 2001 is $42.09 and there are 271.5 total shares outstanding.
Therefore the market value of equity is:
Current share price * Average shares outstanding: (42.09 * 271.5) = $11,427.44 million
This figure is much higher than the book value of $3,494.5 million that Cohen used to calculate the value of equity.
Cost of Equity...

...Value-EBIT Value-Sales Price-Book value
Equity valuation
In conjunction with the valuation of Coles Group, contained in “Excel03 Equity valuation”
Real options valuation
Equity markets price shares above the present value of expected future cash flows, due to the presence of embedded options not captured by DCF analysis Real options valuation is introduced in FINM3401 Corporate Finance.
1
Dividend discount model (1)
E=
Dividend discount model (2)
Terminal valuen
∑ (1 + k ) = ∑ (1 + k )
Dt Dt
t =1 t e t =1 e
∞
n
t
+
(1 + ke )t
Equity value under the assumption of constant growth (which necessarily incorporates an assumption of a constant REINVESTMENT RATE and a constant expected return on reinvested earnings): n
Equity value per share is the present value of expected future dividends. Typical process is to estimate expected dividends for an explicit forecast period of, say, 3 – 10 years before making some assumption about dividends thereafter. The present value of these dividends thereafter is referred to as the terminal value (the value which you would expect to sell the shares for at the end of the explicit forecast period). The most common assumption is that dividends continue at a constant growth rate thereafter. But you do not necessarily have to assume constant growth.
E=
∑ (1 + k ) + (k − g )(1 + k ) g = (1 − DPR ) × E ( ROE )
Dt
t =1 t e e e e...

...The word ‘equity’ can be seen to have a wide range of meanings- to many it is a synonym for ‘fairness’ or justice’. Those within the legal community recognise equity as the body of rules developed and applied by the Court of Chancery; a court previously presided over by the Lord Chancellor with rules developed under his authority. The law of equity developed due to the inflexibility of the common law. Before the development ofequity, The law was rigid (which was often cited as a weakness) for example, claimants would only have a successful claim in common law courts if their claim could be matched with an existing writ and even then, the only remedy available to them was damages, even in cases where monetary compensation was not seen as the most suitable remedy. However, claimants who were unsuccessful in receiving a solution in the common law courts were able to appeal directly to the sovereign, who would then delegate cases to the Lord Chancellor for a decision. The Chancellors’ role, in time, was taken over through the development of the Court of Chancery, the aims of which were to deliver ‘equitable’ or ‘fair’ decisions in cases where justice could not be achieved in the Common law Courts. The creation of equity as a system of law was to serve as a means by which the English legal system could strike the balance between the rule-making process and the need to achieve fair results in individual and...

...TASK 1
The statement by Henry Kravis that private equity was in its “golden era” might sound like hubris to the unacquainted observer but may actually not be far off from the reality given the growth of private equity funds under management since the advent of large-scale leveraged buy-outs (LBOs) in the 1980s. Henry Kravis as a principal partner in Kohlberg, Kravis & Roberts (KKR) pioneered LBOs in the late 1970s and KKR has been a major privateequity firm since having reportedly invested in over 160 companies since 1977 (KKR website, 2009). Henry Kravis spoke on the back of unprecedented record funds raised by private equity firms in 2006. According to the Dow Jones Private Equity Analyst newsletter of January 2007, U.S private equity firms raised $255 billion in 404 funds followed by $302 billion in 415 funds in 2007. In 2007 U.S private equity firms raised this money in the middle of the turmoil of the credit crisis which was just beginning to shake financial markets worldwide.
Private equity as an asset class has always been attractive due to the higher returns as compared to public equity. Many studies have confirmed that private equity investments have consistently outperformed public equity markets. For instance, according to research flash paper released in January 2012 by the firm Partners Group, “since...