Cost of equity capital Essay

IntroductionThe order of return that is ask is employed in evaluating equity and is the least percentage in a year that is gained by investments of a telephoner through the investors. The live of equity is the rate of return on investments that is required by the sh arholders of a company. The paper will discuss the three determines which are the dividend mountth, the CAPM and the arbitrage set theory. This will be in order to determine which one of them is the scoop for anticipating the rate of return required. It will too discuss the factors that form the beta of a company in order to determine the speak to of equity.The best bewilder for estimating the required rate of returnDividend growth model is the best for estimating the required rate of return of the company beca subroutine it is bare(a) in terms of calculations. It is non complicated to apply and enables investors to calculate the growth of their stock easily. This model does not require a specialist and ri ght decisions are made on time. This model enables the unfluctuatings that design it to grow in a rate that is stable and their profits grow at the same level with the dividends. This ensures the investors that the company will meet up their compulsions. It is the best because it is uniform as shareholders do not receive to a greater extent dividends when the company increases profits more than expected. It is a way of determining the value of a share with need to the current value of the dividends that the company expects to achieve in the future. Dividends can be described as the funds 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 as well as certain as the investors are given a stubborn rate of return enabling the company to grow steadily. The model as well has a basis that is consistent as the investors are paid dividends according to their shares. It is to a fault predictable and constant and that is why I would recommend it to the board of directors.Ease of useThe simplicity of using the Capital Asset Pricing Model is because it has got comparatively simple formulae to use. r = rF + *(rM rF)Wherer = requisite rate of return of financial assets = financial character reference betarF = risk free pacerM = required charge of return of market place portfolioThe model as well determines the type of index which suites the company market. For instance, if the blood 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 yahoo monetary resource. The simplicity of the trade Pricing Theory is the fact that the model is not restrictive in comparison to distinct pricing models and theories. The ease use of the divided growth is the fact that it is both easy to use and understand.AccuracyThe the true of the Capital Asset Pricing Model is that it provides accurate and reasonable results. By use of its formulae correctly and plentiful 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 reasonable accurate in order to be effective and accurate. speculationCapital asset pricing model is based on some fundamental assumptions. For instance, it is true that the investors confirm similar homogeneous beliefs based on returns for they are interested in maximizing returns commencing their investors. Additionally, the assumption that to the highest degree people access information on the investment opportunities is evenly practical in a market which is perfect. On the a sset pricing model, the assumption that systematic risks exist is true for the environment operated in is abundant of risks from the external and internal sources. The risks do not have an influence on the investments rate of returns. Under the dividend growth model, the fact that it is a powerful and simple tool to use its application is also limited to the businesses developing at a rate which is stable. The model also scarpers to ignore the organizational cycles where the businesses draw and later declines.The cost 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 survey them and be able to take the possibility of investing in a firm.The cost of equity (E(rj) is equalise to (RRF) plus beta of the security j multiplied by return on market portfolio RM deduction (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 e quity is 0.40% + 1.60(9.50 0.40) = 14.96For McDonalds Corporation the cost of equity is 0.40% + 0.40(8.50% -0.40) = 3.64The company with higher cost of equity is McDonalds Corporation because it has the lowest figure compared to other 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.FactorsSome of the factors that influence a company beta include the companys impose exposure, business risk, the kind of care 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 financing a project for exa mple 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 fast-growing(a) to constructive activities. If the management approach is aggressive, there is room for the company to become firm by the use of vital debts amounts to increase a companys share hence development. On the other hand, if the management is constructive, it is slight 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 proven 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 money for a certain project, the fact remains that the bazaar is struggling and the investors tend to limit the ac cess of companies to capital because of issues with, market concerns. This is likely to affect the company negatively. The financial flexibility allows organizations to boot money even in hard 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/Research/Valuations/Earnings%20Growth%20and%20Stock%20Returns.pdfhttp//www.investopedia.com/university/concepts/concepts8.asp