Cost of equity capital Essay

IntroductionThe prize of return that is required is employed in evaluating equity and is the least function in a year that is gained by investments of a familiarity with the investors. The damage of equity is the tell of return on investments that is required by the sh argonholders of a caller-up. The paper will discuss the three works which are the dividend offset, the CAPM and the trade pricing theory. This will be in order to determine which maven of them is the best for anticipating the value of return required. It will in addition discuss the factors that check the of import of a company in order to determine the woo of equity.The best moldingling for estimating the required rate of returnDividend contractth model is the best for estimating the required rate of return of the company beca riding habit it is simple in terms of calculations. It is not complicated to apply and enables investors to calculate the yield of their line of descent easily. This model does not require a specialist and sinless decisions are made on time. This model enables the firms that use it to grow in a rate that is stable and their profits grow at the same take aim with the dividends. This ensures the investors that the company will meet up their compulsions. It is the best because it is constant as shareholders do not receive more dividends when the company subjoins profits more than expected. It is a way of determining the value of a share with cypher to the current value of the dividends that the company expects to achieve in the future. Dividends can be described as the cash flows that are given back to the shareholders. recommendation to the board of directorsI would recommend to the board of directors that the SLP Company should use the dividend growth model because it is not complicated. It is also certain as the investors are given a mulish rate of return enabling the company to grow steadily. The model also has a buns that is logical as the i nvestors are paid dividends according to their shares. It is also predictable and constant and that is why I would recommend it to the board of directors.Ease of useThe simplicity of using the seat of government Asset Pricing Model is because it has got relatively simple formulae to use. r = rF + *(rM rF)Wherer = requisite rate of return of financial assets = financial fiber betarF = risk free pacerM = required lade of return of commercialize portfolioThe model also determines the type of index which suites the company market. For instance, if the business owner feels that the Russell 3000 best represents the business, it is necessary to use it since it is available. The model also looks for beta asset values as computed by Google, finance and yokel finances. The simplicity of the trade Pricing Theory is the fact that the model is not restrictive in comparison to different pricing models and theories. The ease use of the divided growth is the fact that it is both easy to use and understand. truthThe accuracy of the cracking Asset Pricing Model is that it provides accurate and rational results. By use of its formulae correctly and enough data, accuracy is achieved easily. The fact that the Arbitrage Pricing Theory includes more factors, the theory is also considered more accurate in comparison with the Capital Asset Pricing Model. Since the dividends are fixed during payment, the divided growth is also an accurate method. The method also requires middling accurate in order to be effective and accurate.AssumptionCapital asset pricing model is based on some primeval assumptions. For instance, it is true that the investors have similar homogeneous beliefs based on returns for they are interested in maximizing returns commencing their investors. Additionally, the assumption that most people rag information on the investment opportunities is evenly practical in a market which is perfect. On the asset pricing model, the assumption that systematic risks exist is true for the environment operated in is full of risks from the external and internal sources. The risks do not have an puzzle out on the investments rate of returns. Under the dividend growth model, the fact that it is a powerful and simple appliance to use its application is also limited to the businesses developing at a rate which is stable. The model also melt downs to ignore the organizational cycles where the businesses begin and by and by declines.The live of equity is an evaluation that is used in analysis which shows the rate of return that an investor requires. This involves the dividends to evaluate them and be able to take the possibility of investment funds in a firm.The monetary value of equity (E(rj) is equal to (RRF) plus beta of the security j multiplied by return on market portfolio RM minus (E(rj)= RRF+ j(RM RRF)For Nike Company the cost of equity is 0.40% + 0.9(6.50% 0.40%) =5.89For Sony corporation the cost of equity is 0.40% + 1.60(9.50 0.40) = 1 4.96For McDonalds Corporation the cost of equity is 0.40% + 0.40(8.50% -0.40) = 3.64The company with higher(prenominal) cost of equity is McDonalds Corporation because it has the lowest figure compared to new(prenominal) companies. This is because the return is too low which indicates that the cost of equity is high. The theory of finance suggests that when the possibility of investing in a company is high the cost of equity also goes high and when the possibility decreases the cost also goes down.Factors both(prenominal) of the factors that influence a company beta include the companys tax exposure, business risk, the kind of counselling style, financial flexibility, the market conditions and the growth rates. These factors influence the company beta in different ways.The companys tax exposure affects the company beta in that the debt payments tax is deductable. Therefore, if the originations tax rate is at a high position, by use of debt as a channel of financial backing a proj ect for example is attractive for the deductable tax debts protects profits for the taxes. On the business risk, if the organization risk is high, the optimal arrears ratio is lower.The kind of management style lies between aggressive to constructive activities. If the management approach is aggressive, in that location is room for the company to become firm by the use of vital debts amounts to increase a companys share so development. On the other hand, if the management is constructive, it is less disposed to use the debts as a way of increasing profits. Some of the companies that acquire their finances from borrowing and debts among other methods tend to find conflicts associated with these because the growth firm revenues are not proved and are typically unstable.The market conditions are also influential on the companys beta. For instance, if a firm has got the need to borrow bills for a certain project, the fact remains that the bazaar is struggling and the investors tend to limit the access of companies to capital because of issues with, market concerns. This is likely to affect the company negatively. The financial flexibility allows organizations to raise money even in intemperately times. The higher financially stable a company is, the less the debts and hence fast development.ConclusionThe paper has discussed the ease of the three models which include the dividend growth, CAPM and the arbitrage return theory. It has also discussed into details the accuracy and the reality of each model in order to determine which one is the best for the company. It has shown that the dividend growth model is the best because it is easy for the company and investors to apply and calculate, it is certain and predictable, has logical basis and is constant because an increase in the earnings does not lead to increase in dividends to the investors which is very beneficial to the company. It has also discussed into details the type of factors that influence the beta of the company. The paper has also done calculations to determine the company with the highest cost of equity. It has also discussed the factors that lead to higher beta of the company.Referenceshttp//www.investopedia.com/terms/g/gordongrowthmodel.asphttp//pages.stern.nyu.edu/adamodar/pdfiles/valn2ed/ch13.pdfhttp//latrobefinancialmanagement.com/ interrogation/Valuations/Earnings%20Growth%20and%20Stock%20Returns.pdfhttp//www.investopedia.com/university/concepts/concepts8.asp