COMMERCE 3FA3 Chapter : 3FA3-CH14.docx

• School: McMaster University
• Department: Commerce
• Course: COMMERCE 3FA3
• Professor: Trevor Chamberlain

Document Summary

Use required return, appropriate discount rate, and cost of capital interchangeably. The cost of the capital associated with an investment depends on the risk of that investment. The cost of capital depends primarily on the use of the funds, not the source. We take the firm"s financial policy as given. We assumes the firm has a fixed debt/equity ratio that it maintains. The d/e ratio reflects the firm"s target capital structure. A firm"s cost of capital reflects both its cost of debt capital and its cost of equity capital. The return that equity investors require on their investment in the firm. 2 approaches to determining the cost of equity: the dividend growth model approach and the security market line (sml) approach. The firm"s dividend will grow at a constant rate, the price per share of stock, po, can be written as: D1 is the next period"s projected dividend. Re for the required return of stock.