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Cost of equity

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35:, to compensate for the risk they undertake by investing their capital. Firms need to acquire capital from others to operate and grow. Individuals and organizations who are willing to provide their funds to others naturally desire to be rewarded. Just as landlords seek rents on their property, capital providers seek returns on their funds, which must be commensurate with the risk undertaken. 89:
increases/decreases, its cost of capital increases/decreases: capital providers expect reward for offering their funds to others. Such providers are usually rational and prudent preferring safety over risk. They naturally require an extra reward as an incentive to place their capital in a riskier
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Proposed by Gebhardt et.al. (2001) - see Further Reading Section. The paper shows that a firm’s implied cost-of-capital is a function of its industry membership, B/M ratio, forecasted long-term growth rate, and the dispersion in analyst earnings
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While a firm's present cost of debt is relatively easy to determine from observation of interest rates in the capital markets, its current cost of equity is unobservable and must be estimated. At the least, though, as a firm's
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investment instead of a safer one. If an investment's risk increases, capital providers therefore demand higher returns or they will place their capital elsewhere.
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Firms obtain capital from two kinds of sources: lenders and equity investors. From the perspective of capital providers, lenders seek to be rewarded with
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Francis, Jennifer; Lafond, Ryan; Olsson, Per M.; Schipper, Katherine (2004). "Costs of Equity and Earnings Attributes".
81:. Such decisions can be made after quantitative analysis that typically uses a firm's cost of capital as a model input. 118:
The Bond Yield Plus Risk Premium (BYPRP), adds a subjective risk premium to the firm's long-term debt interest rate.
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A firm's overall cost of capital, which consists of the two types of capital costs, is then determined as the
101: 50:). From a firm's perspective, they must pay for the capital it obtains from others, which is called its 211:
Gebhardt, William; Lee, Charles; Swaminathan, Bhaskaran (2001). "Toward an Implied Cost of Capital".
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model to estimate the market implied cost-of-capital, and the cost of equity can then be backed-out.
69:. Knowing a firm's cost of capital is needed in order to make better decisions. Managers make 267: 115:
model based on dividend returns and eventual capital return from the sale of the investment.
112: 8: 93: 96:(and practice) offers various models for estimating a particular firm's cost of equity: 181: 164: 70: 220: 199: 176: 145: 135: 122: 51: 262: 203: 28: 256: 224: 140: 108: 47: 32: 78: 43: 39: 74: 20: 189: 86: 31:) a firm theoretically pays to its equity investors, i.e., 121:
The cost of equity can be calculated using the discounted
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decisions while capital providers make decisions about
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and attributed to these two kinds of capital sources.
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and/or appreciation in the value of their investment (
254: 163:Fama, Eugene F.; French, Kenneth R. (1997). 180: 54:. Such costs are separated into a firm's 255: 27:is the return (often expressed as a 13: 156: 14: 279: 151:Weighted average cost of capital 67:weighted average cost of capital 239: 213:Journal of Accounting Research 169:Journal of Financial Economics 1: 232: 182:10.1016/S0304-405X(96)00896-3 7: 129: 104:, or CAPM, is prototypical. 102:capital asset pricing model 10: 284: 204:10.2308/accr.2004.79.4.967 165:"Industry costs of equity" 42:and equity investors seek 225:10.1111/1475-679X.00007 192:The Accounting Review 113:discounted cash flow 71:capital budgeting 275: 247: 243: 228: 207: 186: 184: 146:Return on equity 283: 282: 278: 277: 276: 274: 273: 272: 253: 252: 251: 250: 244: 240: 235: 198:(4): 967–1010. 159: 157:Further reading 136:Cost of capital 132: 123:residual income 52:cost of capital 17: 12: 11: 5: 281: 271: 270: 265: 249: 248: 237: 236: 234: 231: 230: 229: 219:(1): 135–176. 208: 187: 175:(2): 158–193. 158: 155: 154: 153: 148: 143: 138: 131: 128: 127: 126: 119: 116: 105: 94:Finance theory 60:cost of equity 29:rate of return 25:cost of equity 16:Financial term 15: 9: 6: 4: 3: 2: 280: 269: 266: 264: 261: 260: 258: 242: 238: 226: 222: 218: 214: 209: 205: 201: 197: 193: 188: 183: 178: 174: 170: 166: 161: 160: 152: 149: 147: 144: 142: 139: 137: 134: 133: 124: 120: 117: 114: 110: 106: 103: 99: 98: 97: 95: 91: 88: 82: 80: 76: 72: 68: 63: 61: 57: 53: 49: 45: 41: 36: 34: 30: 26: 22: 268:Shareholders 241: 216: 212: 195: 191: 172: 168: 141:Depreciation 109:Gordon Model 92: 83: 64: 59: 56:cost of debt 55: 48:capital gain 37: 33:shareholders 24: 18: 257:Categories 246:forecasts. 233:References 79:investment 44:dividends 130:See also 40:interest 111:, is a 75:lending 21:finance 23:, the 263:Costs 107:The 100:The 87:risk 77:and 58:and 221:doi 200:doi 177:doi 19:In 259:: 217:39 215:. 196:79 194:. 173:43 171:. 167:. 227:. 223:: 206:. 202:: 185:. 179::

Index

finance
rate of return
shareholders
interest
dividends
capital gain
cost of capital
weighted average cost of capital
capital budgeting
lending
investment
risk
Finance theory
capital asset pricing model
Gordon Model
discounted cash flow
residual income
Cost of capital
Depreciation
Return on equity
Weighted average cost of capital
"Industry costs of equity"
doi
10.1016/S0304-405X(96)00896-3
doi
10.2308/accr.2004.79.4.967
doi
10.1111/1475-679X.00007
Categories
Costs

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