# Calculating the Internal-Equity Cost of Capital

The cost of internal-equity capital to the firm is imputed to be the rate of return required by the

investors to purchase the firm’s stock. The imputed internal equity cost of capital can be

Don't use plagiarized sources. Get Your Custom Essay on
Calculating the Internal-Equity Cost of Capital
Just from \$13/Page

calculated in many ways, all of which have limitations in application. Two of the more common

methods, which we have discussed before, are

1. dividend growth model

2. capital asset pricing model

Dividend growth model—In theory, the internal-equity common stock’s value could be

calculated by discounting from now to infinity the stream of dividends at the investors’ required

rate of return. In practice, dividends cannot be estimated with confidence, therefore a simple

approach is to assume a constant dividend growth rate (g).

The basic formula used to represent a constant dividend stream to infinity is:

Pcs = D1/(kcs – g)

where D1, the next dividend, is related to D, the last dividend, by the following formula:

D1 = D(1 + g)

Rearranged algebraically to solve for kcs:

kcs = (D1/ NPcs) + g

or

kcs = [(D (1 + g))/ NPcs] + g

where:

Pcs = the imputed common stock price

kcs = the common stock after-tax cost of capital (not tax deductible)

D = the last common stock dividend

D1 = the next common stock dividend

g = the steady-state growth rate for dividends

Example

Echo Corporation common stock is currently selling for \$22.00/share. Its present dividend is

\$0.96/share, and its expected long-term dividend growth rate is 8.5%. What is Echo’s cost of

internal equity (kcs)?

Organize the data:

D1 = D(1 + g)

D1 = .96(1 + .085) = 1.0416

NPcs = \$22.00

Formula:

kcs = (D1/NPcs) + g

Calculation:

kcs = (1.0416/22.00) + .085 = .1323

kcs = 13.23%

Capital asset pricing model—The second model for calculating internal common stock equity

is the capital asset pricing model (CAPM). It addresses the valuation of equity cost of capital

from the standpoint of the return required by stockholders for a given level of risk.

The return required for internal common stock equity is equal to risk-free return + a risk

premium that varies from stock to stock:

kcs = rrf + Bj(rm – rrf)

where:

Bj = beta and is normally estimated by historical values between a security’s return and

the market return

rrf = the risk-free rate and is usually estimated at the U.S. Treasury bill rate

rm = market risk

Example

Echo’s current beta value is 0.75. Treasury bills are currently yielding 5.5%, and the market

return is 14.3%. What is Echo’s internal cost of equity capital? Market return is 14.3%.

Organize the data:

rrf = –5.5%

Bj = .75

Formula:

kcs = rrf + Bj (rm – rrf) )

Calculation:

kcs = 5.5 + .75(14.3 – 5.5)

kcs = 12.1%

Pages (550 words)
Approximate price: -

Why Work with Us

Top Quality and Well-Researched Papers

Our writers have been trained on how to handle papers placed by our clients. The writer must read and understand before embarking on writing the papers. In case of any issue that needs clarification, writers are encouraged to ask the client or support.

Our team comprises of the best writers and editors. We do thorough vetting during recruitment to make sure that our writers have the knowledge and experience we aspire in the team.

Free Unlimited Revisions

Our aim is to give the client the best outcome. If for some reason you are not satisfied with the wok done, you can ask the paper to be revised or rewritten. This will be done to your satisfaction with no extra charges.

Prompt Delivery and 100% Money-Back-Guarantee

We have writers who work round the clock. This helps in making sure that all our clients’ papers are delivered on time. If we have issues with the deadline, we will ask for extension. If its not possible, the money is fully refunded.

Original & Confidential

Our clients’ confidentiality is highly respected. We can never disclose our clients’ details to third parties. In the same regard, we strive to give our clients 100% original papers. We do not tolerate plagiarism from our writers.

Clients can reach us any time of the day, and any day of the week. There is a live chat, email or phone numbers to help in ease of communication.

Try it now!

## Calculate the price of your order

Total price:
\$0.00

How it works?

Fill in the order form and provide all details of your assignment.

Proceed with the payment

Choose the payment system that suits you most.

Our Services

You should never be worried about your papers even in the middle of the night. Our team will work round the clock to deliver.

## Essay Writing Service

We have an able team that can deliver your work in the shortest time possible. The academic level or the type of work should never be a hindrance. Our highly competent support team is always around (24/7) to give you any assistance you may need.