UGC NET COMMERCE November 2017(Paper-II) Q34

0. Which one of the following is not a method of calculating cost of equity capital?

  • Option : C
  • Explanation : Cost of equity capital: Cost of equity is the projected rate of return by the equity shareholders. Cost of equity share capital can be defined as the minimum rate of return which a firm must earn on the equity part of total investment in a project to facilitate no change in the market price of such shares. In order to determine the cost of equity capital, it may be divided into two categories:
    ∎ External equity or latest issue of equity shares.
    ∎ Retained earnings.
    It can be calculated as per the following approaches:
    1. Dividend yield/dividend price approach: According to this approach, the cost of  equity will be that rate of expected dividends which will sustain the present market price of equity shares. It is computed with the following formula:
    Ke = D/NP (for new equity shares)
    or
    Ke = D/MP (for existing shares)
    Where Ke is the cost of equity, D is the expected dividend per share. NP is net proceeds per share and MP is market price per share.
    2. Dividend yield plus growth in dividend methods: According to this method, the cost of equity is computed on the basis of the expected dividend rate plus the rate of growth in dividend. This technique is used when dividends are projected to grow up at a constant rate. Cost of equity is calculated as:
    Ke = D1/NP + g (for new quity issue)
    where D1 is expected dividend per share at the end of the year. [D1 = D0 (1 + g)], NP is net proceeds per share and g is the growth in dividend for existing share calculated as:
    D1/MP + g
    where MP is the market price per share.
    3. Earnings yield method: According to this approach, the cost of equity is the discount rate that capitalizes a flow of future earnings to calculate the shareholdings. It is called by taking earnings per share (EPS) into consideration. It is calculated as:
    1. Ke = Earnings per share/Net proceeds
    = EPS/NP (for new share)
    2. Ke = EPS/MP (for existing equity).
Cancel reply

Your email address will not be published. Required fields are marked *


Cancel reply

Your email address will not be published. Required fields are marked *