5 Questions
What does Kr represent in the context of retained earnings?
Opportunity cost of dividends foregone by shareholders
Which formula is used to calculate the cost of retained earnings?
(D1 / MP) + G
What does WACC stand for?
Weighted Average Cost of Capital
In WACC calculation, what is the purpose of assigning weights to specific costs?
Determining the proportion of each source of funds in the total capital structure
What is Ke in the context of retained earnings computation?
Rate of return available to shareholders
Study Notes
- Cost of equity capital is the maximum rate of return a company must earn on equity finance to maintain its stock market price.
- Methods to compute cost of equity include dividend yield, dividend yield plus growth, and earning price approach.
- The cost of capital is the minimum rate of return a firm must earn on its investment to prevent a decrease in the market value of its equity shares.
- It comprises three components: return at zero risk level, premium for business risk, and premium for financial risk.
- Cost of retained earnings is the opportunity cost of dividends foregone by shareholders, calculated based on expected dividends, growth rate, and market price per share.
- Weighted Average Cost of Capital (WACC) is calculated by determining specific costs of each capital component and assigning weights based on the proportion of each source of funds in the total capital structure.
Test your knowledge on the calculation of cost of equity capital, which is the rate of return a company must earn on equity finance to maintain its stock price. Learn about the Dividend yield method, Dividend/price ratio method, and Dividend yield plus growth in dividend method.
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