Financial management ipcc cost of capital

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Chintan Patel (Querist)
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02 January 2014 Hello Everyone!
Can anyone please explain me this formula

cost of equity=dividend/market price*100+Growth

Why do companies take Market value for ascertaining COE?since what they get during issue is face value+premium?

And please explain the growth concept also(my confusion:shouldn't growth be ignored as it pertains to future years and for ascertaining COE,we just take cost per year)..

-Thank You

CS,CA F,Numrologi TusharSampat

CS,CA F,Numrologi TusharSampat (Expert)
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02 January 2014 Firstly when shares are issued at cost or at premuim it will not be of much help for any co later because what exactly the shares may fetch in current market at present will be of more imp as when u purchase it after 1 year of issue it will definetly have more or lesser value than its original price issued.

secondly growth aspect of co is imp as investor will always want to invest in a growth oriented co so when he reselles it then he will naturally want more capital gains in order to increase his wealth...

so always coe will be including growth and div aspect.

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Ashok

Ashok (Expert)
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02 January 2014 Look at it firstly, from the investor's point of view. The return he will get from the stock has two components
a) Dividends
b) Price Appreciation
Dividend return is measured as D/P also called dividend yield.
Price appreciation is related to the earnings growth of the company. Earnings growth is like a proxy to the growth of the company's stock price. The sum of the above given his total return.
Now the investor's total return is also the cost to the company ie cost of equity. This is a notional cost in the sense it is not like debt where the cost is immediately known in the form of coupons.

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Chintan Patel

Chintan Patel (Querist)
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02 January 2014 Thank You Ashok Sir and Tushar Sir!
1.Does this mean that Growth is just a notional cost and not actual?

for example...Face Value=10; market value=540; Investors expect a return of rs.27.Though their expectation is just 5% of the market price,but to company its 270%,is it not?please correct if if i am wrong...

Thank You very much...

Ashok

Ashok (Expert)
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02 January 2014 That's not correct. If the investor is expecting say 5% as in your example - first let's imagine what the dividend yield on the stock would be. Let's say the company pays 40% dividend ie Rs.4. The div yield is 4/540 = 0.74%. The cap appreciation required is 5%-0.74%=4.26%. The expected price then is 540+4.26% = 563.30
So when the price reaches 563.3 the investor realises his full 5% return.
Now the question is what time period? It's typically over one year.

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