BF 3215/3201

Corporate Finance & Strategy

Lecture 4
Cost of Common Equity
And Preferred Stock

Dr. Siri Chutikamoltham

 Intuition for Financing that Max Firm Value
◼ Firm Value: E CF$,t 
n

V = 
t =1
(1 + k )t
⚫ The discount rate is risk-adjusted WACC
⚫ If capital consists of Debt, Common Equity, Preferred Stock:
• WACC = wdkd( 1-T) + weke + wpfkpf
• The lower the discount rate, the higher Firm Value
⚫ Thus, managers need to understand:
• The Cost of Debt
• The Cost of Common Equity
• The cost of Preferred Stock
• The optimal D/E
Dr. Siri Chutikamoltham
2
 Lecture Objectives
◼ Understand the cost of
⚫Common Equity
⚫Preferred Stock
◼ Understand features of common and preferred stocks
◼ Understand factors that affect required return on stocks
◼ Understand methods to estimate cost of equity
◼ Issues and limitations in estimating cost of equity in
the real world

Dr. Siri Chutikamoltham

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 Common and Preferred Stocks are
Financial Assets

0 1 2 n
k ...
Value CF1 CF2 CFn

CF1 CF2 CFn

PV = + + ... +
(1+ k) 1
(1+ k) 2
(1+ k) n

Dr. Siri Chutikamoltham

4
 Main Features of Common Stock
◼ Ownership
◼ Voting right, control
◼ Board of Directors
◼ Dividend, optional, not tax-deductible to firm
◼ Limited liability
◼ No maturity
◼ Last on the priority of claims, most risky

Dr. Siri Chutikamoltham

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 Classified Stock

◼ Classified stock has special provisions.

◼ Could classify existing stock as founders’ shares,
with voting rights but dividend restrictions.
◼ New shares might be called “Class A” shares, with
voting restrictions but full dividend rights.

Dr. Siri Chutikamoltham

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 Tracking Stock
◼ The dividends of tracking stock are tied to a
particular division, rather than the company as a
whole.
⚫Investors can separately value the divisions.
⚫Its easier to compensate division managers with
the tracking stock.
◼ But tracking stock usually has no voting rights,
and the financial disclosure for the division is not
as regulated as for the company.

Dr. Siri Chutikamoltham

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 Types of Common Equity
◼ 1. Retained Earnings.
◼ 2. New shares of common stock.
◼ Is there a cost for retained earnings?

Dr. Siri Chutikamoltham

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 Widely-used Methods
to determine cost of equity, ks
1. Dividend Growth Model (DDM): ks = D1/P0 + g

2. CAPM: ks = kRF + (kM - kRF)b

= kRF + (RPM)b
3. Own-Bond-Yield-Plus-Equity Risk Premium:

ks = kd + RP
Note: RP is the risk premium over own corporate bond yield, not the same as
Market Risk Premium in CAPM (RPM )

Dr. Siri Chutikamoltham

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 Widely-used Methods
to determine cost of equity, ks (cont)

% of Australia Hong Indonesia Malaysia Philippines Singapore

firms that Kong
use

CAPM 72.7 26.9 0 6.2 24.1 17.0

Dividend 16.4 53.8 33.3 50.0 34.5 42.6
Growth
Kd + 10.9 23.1 53.4 37.5 58.6 42.6
Premium

Source: George Kester et.al.,” Capital Budgeting Practice in the Asai-Pacific Region

Dr. Siri Chutikamoltham

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 Dividend Growth Model
Stock Value = PV of Dividends

 = D1 D2 D3 D
P + + +. . .+
0
(1 + k ) (1 + k ) (1 + k )
s
1
s
2
s
3
(1 + k )
s


0 = D1 D2
P + +
(1 + k ) (1 + k )
s
1
s
2

PV2

Dr. Siri Chutikamoltham

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 Estimate Cost of Equity
1. Dividend Growth Model

◼Possible patterns of dividend growth pattern:

⚫Constant growth rate
⚫Non-constant growth

Dr. Siri Chutikamoltham

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 A Constant Growth Stock
A stock with dividends that are expected to
grow forever at a constant rate, g.

If g is constant, then: D1 = D0( 1+g)

P = D0 (1 + g) = D1
ks − g ks − g
0

Gordon Growth Model (GGM)

Dr. Siri Chutikamoltham

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 What happens if g > ks?

D1
P 0 = requires k s > g.
ks − g
◼ If ks< g, get negative stock price, which is nonsense.
◼ We can’t use model unless (1) g < ks and (2) g is
expected to be constant forever.
◼ g is the long-term growth rate, realistically it cannot
be > ks because if a business tries to achieve hyper
growth rate for years, the risk must rise so the
required return must also rise
Dr. Siri Chutikamoltham
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Ex. D0 was $2.00 and g is a constant 6%.
Find the expected dividends for the next
3 years, and their PVs, ggiven ks = 13%.

0 g=6% 1 2 3 4

D0=2.00 2.12 2.2472 2.3820….

13%
1.8761
1.7599
1.6508
Dr. Siri Chutikamoltham
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What’s the stock’s intrinsic value?
D0 = 2.00, ks = 13%, g = 6%.
Constant growth model:

 D0 (1+ g) D1
P0 = =
ks − g ks − g

$2.12 $2.12
= = = $30.29.
0.13 - 0.06 0.07
Dr. Siri Chutikamoltham
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What is the stock’s intrinsic value one year
^
from now, or P1?
◼ D1 will have been paid, so expected dividends are
D2, D3, D4 and so on. Thus,

D2
P̂1 =
ks − g
$2.2472
= = $32.10.
0.07

Dr. Siri Chutikamoltham

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Find the expected Dividend yield and Capital
gains yields if you hold the stock for one year?

D1
Dividend yield = =
P0

^
P1 - P0
CG Yield = =
P0

Dr. Siri Chutikamoltham

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 Find the total return if hold stock for one year
◼ Total return = Dividend yield + Capital gains yield.
◼ Total return for this stock = ?
◼ If market is efficient, Total return = Required rate of return
on equity
 D1  D1
P = to k = + g.
0
ks − g s
P0

◼ Then, ks = $2.12/$30.29 + 0.06

◼ = 0.07 + 0.06 = 13%
◼ What is the Capital gains yield?
◼ For constant growth stock: Capital gains yield =……

Dr. Siri Chutikamoltham

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 Zero-Growth Dividend Stock
What would P0 be if g = 0?
The dividend stream would be a perpetuity.

0 k =13% 1 2 3
s

2.00 2.00 2.00……

^ PMT $2.00
P0 = = = $15.38
k 0.13
Dr. Siri Chutikamoltham
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What are the expected Dividend, Capital gains
and Total yields if you hold the stock for one
year?

Dividend yield =

CG Yield =

Total Yield =

Dr. Siri Chutikamoltham

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If g = -6% constant, would anyone buy the
stock? If so, at what price?

Dr. Siri Chutikamoltham

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 If g = -6% constant,
what are the expected Dividend,
Capital gains and Total yields?

• Capital gains yield =

• Dividend yield =

• Total Yield =

Dr. Siri Chutikamoltham

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Summary: Stock Value and Growth Rate

Growth Stock Dividend Capital Total Yield

Value $ Yield % gains %
Yield %
6% 30.29 7% 6% 13%
constant

0% 15.38 0% 13% 13%

constant

-6% 9.89 19% -6% 13%

constant

Dr. Siri Chutikamoltham

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 Non-Constant Growth Dividend Stock

◼If the stock has supernormal growth of

30% for 3 years, then a long-run constant g
= 6%, what is P0 if ks is still 13%?
◼Can no longer use constant growth model.
◼However, growth becomes constant after 3
years.

Dr. Siri Chutikamoltham

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Ex. Non-constant growth followed by constant growth:

0 k =13% 1 2 3 4
s

g = 30% g = 30% g = 30% g = 6%....

D0 = 2.00 2.60 3.38 4.394 4.6576
2.3009
2.6470
3.0453
$4.6576
P̂3 = = $66.5371
46.1135 0.13 − 0.06
^
54.1067 = P0
Dr. Siri Chutikamoltham
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What are the expected dividend capital
gains and total yields for the first year?

Dividend yield =

CG Yield =

Total Yield =

Dr. Siri Chutikamoltham

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 Ex. Constant growth follows by constant growth
Suppose g = 0 for t1 to t3, and g is a constant
growth rate of 6%. What is P ^?
0

0 1 2 3 4
ks=13%
...
g = 0% g = 0% g = 0% g = 6%...
2.00 2.00 2.00 2.12

1.7699
1.5663
1.3861
20.9895 P = 2.12 = 30.2857
3
25.7118 0.07
Dr. Siri Chutikamoltham
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What are the expected dividend capital
gains and total yields for the first year?

Dividend Yield =

Capital Gains Yield =

Total Yield =

Dr. Siri Chutikamoltham

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 Summary Equity Value and Growth Rate
◼ Compare higher growth to lower growth stocks,
everything else the same:
⚫Stocks with higher growth, their value will be
higher than those with lower growth
⚫Thus, projected future growth rate is important to
the stock value, thus, the value of the firm
⚫Stocks with higher growth, their capital gain yields
will be higher than those with lower growth
⚫Total return on equity = capital gain yield +
dividend yield
Dr. Siri Chutikamoltham
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Why are stock values volatile?

^ D1
P0 =
ki − g

Dr. Siri Chutikamoltham

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 Stock Prices vs. Changes in ks and g
D1 = $2, ks = 10%, and g = 5%:

P0 = D1 / (ks-g) = $2 / (0.10 - 0.05) = $40. g

ks 4% 5% 6%
What happens if ks or g change?
9% 40.00 50.00 66.67
Relationship between cost of
equity and stock value
10% 33.33 40.00 50.00
• The higher the required rate of
return on equity, the lower the
stock value, other things remain 11% 28.57 33.33 40.00
the same
• The higher the growth rate, the
higher the stock value, other
things remain the same
Dr. Siri Chutikamoltham
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Issues When Use Dividend Growth Model in Real
World
1. Applied only to stocks that pay dividend
⚫ Applicable to mature stocks that pay
dividends, not young, fast-growing stocks
that often retain all earnings for growth
2. GGM: Growth rate (g) is assumed to be
constant, not necessarily true in practice
3. Difficult to forecast g accurately
4. Cannot apply if g> ks

Dr. Siri Chutikamoltham

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 How to estimate dividend and its growth in practice?

◼ 1. Dividend growth rate = (Dividend Yr.T+1/ Dividend Yr.T ) - 1

⚫ Example: D0 = 1.0, D1 = 1.07, D2 = 1.145, g = (D2/(D1) - 1 = 0.07
= 7%
◼ 2. Study the stock’s past dividend pattern, project same pattern into the
future because in practice, companies do not change their dividend
policy unless they have no other choices
⚫ Example:
⚫ if past dividends were $1.00, $1.07, $1.145.., g = 7%
⚫ if past dividends were $1.00, $1.0, $1.0.., g = 0%
⚫ if past dividends were $1.00, $1.10, $1.20.., future dividend rises by
$0.1per year

Dr. Siri Chutikamoltham

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 How to estimate dividend and its growth in practice?
(cont)
◼ 3. If past dividend growth rate varies from year to year, use the average growth
rate:
⚫ Example: g1 = 2%, g2 = 4%, g3 = 7%, g4 = 5%, g5= 3%, arithmetic average
g = 4.2%
⚫ Example: D1 = $1.0, D2 = $1.10, D3 = $1.05, D4 =$1.20, D5 = $1.25,
geometric average (CAGR) = (1.25/1.0)^1/5 – 1.0 = 1.0456-
1.0=0.456=4.56%
⚫ If study dividend for a long period, better to use geometric average
◼ 4. If the stock just starts to pay dividend, hence limited history
⚫ Use industry’s average g
◼ 5. Estimate Sustainable growth rate
⚫ Sustainable growth rate = max growth rate without additional external
financing
⚫ g = ROE x (1- dividend pay-out ratio)
Dr. Siri Chutikamoltham
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 Estimate Cost of Equity
Based on the CAPM

SML of CAPM
ks = kRF + RPM x beta
Ex. Treasury bond yield =3.5%, Market Risk Premium =
7%, beta of the stock = 1.5
ks = 3.5 % + 7 % x 1.5 = 14%

Dr. Siri Chutikamoltham

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Issues related to CAPM in the real world

◼1. Risk-free rate

◼2. Market risk premium
◼3. Different types of betas

Dr. Siri Chutikamoltham

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 1. Issues about the Risk-free Rate
◼ There is no absolute risk-free rate
◼ Some governments defaulted on their loans
◼ In practice, however, the government of a country is often
considered the safest borrower for that country
◼ KRF is approximated by the safest debt among borrowers in a
country
◼ Governments that are financially strong receive AAA ratings for
their bond issues
◼ US government treasury bonds receive AAA ratings from
Moody’s and Fitch, but AA+ from Standard & Poor’s, and yet
US Treasury yield is still used for KRF
Source: US Treasury Data
http://people.stern.nyu.edu/adamodar/pc/datasets/histretSP.xls
Dr. Siri Chutikamoltham
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 1. Issues about the Risk-free Rate
Which Rate?

◼ Which rate to represent KRF? Why?

⚫ Average US T-bill rate (1928-2019)* ~ 3.4-4.0%
⚫ Average US T-bond rate (1928-2019) ~ 5.2-5.6%
⚫ US T-bill rate long-term average* 4.24%
⚫ US 10-year T-bond rate long-term average* 4.35%
⚫ US 20-year T-bond rate long-term average* 4.45%
⚫ US 20-year T-bond rate long-term average* 4.88%

*Source: Federal Reserve **Source: Ycharts.com

Dr. Siri Chutikamoltham
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 1. Issues about the Risk-free Rate
Which Rate?(cont)
◼ T-bill rate is theoretically correct as CAPM is a one-period model
◼ T-bond rate is, on average, less volatile
◼ Many analysts/managers prefer T-bond rate
⚫ Only 21% used T-bill rates
⚫ The majority used T-bond rate regardless of the life of the project to finance: most
popular is10-year rate (46%), consistent with Brotherson’s research
⚫ Many did not use the current treasury rate (the correct one) , but use an average
historical rates, or a forecast rate
◼ Main Considerations:
⚫ Theoretical validity
⚫ Desired level of rate stability
⚫ Length of the funding : ideally should use current kRF of maturity matching to the
length of time to finance
⚫ Bias from input selection: T-bond rate > T-bill rate, so if use T-bond rate, you tend
to over-estimate kRF, thus, WACC
Dr. Siri Chutikamoltham
* Do you Know Your Cost of Capital, HBR 40
What do analysts in the US use for risk-free rate?

Source: Brotherson, Eades, Harris, and Higgins (2013)

Dr. Siri Chutikamoltham

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 What if the government bond rating is not risk-free?
◼ Approximate the risk-free rate by:
⚫ Government bond yield –
sovereign default spread
◼ Credit default swaps, or CDS, are
credit derivative contracts that enable
investors to swap credit risk on a
company, country, or other entity
with another counterparty*
◼ Sovereign Credit Default Spread is
the compensation for the counter
party to take on the sovereign risk
◼ Ex. May 2021, Argentine treasury
bond yield is 50%, CDS spread
~1,770 basis points***and the credit
rating by Moody’s is Ca***

Source: *Investopedia **World Government Bond,

***Statista.com
Dr. Siri Chutikamoltham
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What if the government bond rating is not risk-free?
Moody's Sovereign
Rating Typical Sovereign Default Spread
◼ Approximate risk-free
Aaa
Aa1
0.00%
0.59%
rate for Argentina
Aa2 0.74%
Aa3
A1
0.90%
1.04%
◼ = 50.65 – 17.79 =
A2 1.26% 32.86%
A3 1.78%
Baa1 2.37%
Baa2 2.82% ◼ The risk-free rate
Baa3 3.26%
Ba1 3.71% should be in the same
Ba2 4.45%
Ba3 5.34% currency as your
B1 6.68%
B2 8.16% cashflows
B3 9.65%
Caa1 11.12%
Caa2 13.35%
Caa3 14.82%
Ca 17.79%
C 21.00%
Source: Moodys.com Dr. Siri Chutikamoltham
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 2. Issues about Market Risk Premium
◼ 2.1.How long should the measurement period be?
Pros and Cons
• Longer data = less SD
Historical • But over time, investor
Period Arithmetic Average behaviours may change
• Shorter data = more relevant to
Stocks over Stocks over T. current investor behaviours, but
T. Bills Bonds larger SD
1928-2019 8.18% 6.43% • Main consideration:
• Ideally, relevant market risk
Std Error 2.08% 2.20%
premium should reflect the
1970-2019 7.26% 4.50% current risk premium that
Std Error 2.38% 2.73% investors require for investment
in stock market
2010-2019 13.51% 9.67%
• Hard to know current
Std Error 3.85% 4.87% information, easier to base on
Source: US Treasury Data
http://people.stern.nyu.edu/adamodar/pc/datasets/histretSP.xls historical
Dr. Siri Chutikamoltham
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 2. Issues about Market Risk Premium (cont)
◼ 2.2 MRP for different asset classes
◼ US stock market:
Investment Average Return Risk Premium
Large Co.Stock 10.2% 9.1%
Small Co.Stock 11.9% 15.6%
LT Corporate Bond 5.5% 3.1%
US T-Bill 3.3% 0.0%
◼ Main considerations:
⚫ Consistency : Use MRP for large company stock to estimate cost of
equity of large companies, etc.

Dr. Siri Chutikamoltham

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 What do analysts use in the real world for MRP?

Source: Brotherson, Eades, Harris, and Higgins (2013)

Dr. Siri Chutikamoltham

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What do analysts use in the real world for MRP?(cont)
⚫ The majority used historical market risk premium
• Caveat: Assume that the current risk –reward
relationship for investors is the same as in the past
⚫ Many managers never changed this value over time
⚫ Many managers subjectively assigned values of RPM ;
most popular average 6.5%, range 4% to 9%
⚫ Caution
⚫ RPM = (KM- KRF), but do not calculate from simply
subtract KRF from KM because in practice KM and KRF do
not have a precise one-to-one relationship at a certain point
in time like in the formula.
Source: US Treasury Data
http://people.stern.nyu.edu/adamodar/pc/datasets/histretSP.xls

Dr. Siri Chutikamoltham

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 3. Issues About Beta

◼ 3.1.Different kinds of Betas

⚫ 1. Historical Beta
⚫ 2. Adjusted Beta = 0.67(Historical Beta) + 0.33(1.0)
⚫ 3. Fundamental Beta =
• Bottom-up
• Constantly adjusted to reflect changes in operation
and capital structure
• Main factors included: nature of the business
(stability of earnings, dividend, EPS, assets),
financial leverage (debt/equity), operating leverage
(degree of fixed costs)
Dr. Siri Chutikamoltham
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 3. Issues about Beta (cont)
◼ 3.2. If use historical beta, how long?
⚫ If use long-term data to calculate, more data points, better accuracy
⚫ But stock market conditions change, thus, returns on stocks, long-term data
may not be relevant
⚫ In practice,
• 41% managers use a five-year period
• 15% three years
• 13% two years
• 29% one year*
⚫ Different lengths of period can vary beta by an average 0.25, and WACC by
1.5%*
⚫ Should analyze to find out which is the best representation of the current
relationship between stock returns vs. market returns for your company
*Do you Know Your Cost of Capital, HBR

Dr. Siri Chutikamoltham

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 3. Issues About Beta (cont)
3.3. Beta of a firm with several businesses
⚫ Use weighted average beta
Ex. GM had 3 major divisions

Division Beta Mkt. Value Weight

Automotive 0.95 $22.269 M 55.3%

Hughes Aircraft 0.85 $2,226.M 5.5%
GMAC 1.13 $15,812M 39.2%

GM’s Beta = (0.95 x 0.553) + (0.85 x 0.055) + (1.13 x 0.392)

= 1.02

Dr. Siri Chutikamoltham

Source: Damodaran on Valuation, John Wiley & Sons 50
 How to find Beta estimate?
◼ 1. Popular Websites of information service firms
such as:

Popular Sites

https://finance.yahoo.com/quotes/BETA,Coefficient/ Yahoo Finance

view/v1/
https://www.bloomberg.com/markets/stocks Bloomberg

https://www.valueline.com/Tools/Educational_Articl Value Line Research

es/Stocks/Understanding_Beta.aspx#.XudZnkUzY7c Centre

http://www.abg-analytics.com/stock-betas.shtml ABG Analytics

Dr. Siri Chutikamoltham

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 How to find Beta estimate? (cont)
◼ 2. Financial/ stock reports such as S&P stock report, Value Line
Investment Survey, etc.
◼ But beta value can differ (use with care!!)

Dr. Siri Chutikamoltham

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 How to find Beta estimate?
For Singapore
◼3. More for Singapore stocks

Popular Sites
https://www.shareinvestor.com/prices/stock_prices. Share Investor
html

https://www.infrontanalytics.com/fe- Info Analytics

EN/30265FN/Singapore-Exchange-Ltd-/Beta

https://www.sgx.com/indices/products/sti SGX Site

Dr. Siri Chutikamoltham

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 What Beta do analysts use in the real world?

Source: Brotherson, Eades, Harris, and Higgins (2013)

Dr. Siri Chutikamoltham

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3. Own-bond-yield plus risk-premium method
Ex. YTM of corporate bond currently = 10%,
Equity RP over bond = 4%

ks = kd + RP
= 10+4 = 14%
◼ This RP  CAPM RPM.
◼ Historically, for most stocks, RP~5-7%, with 6%
used most often
◼ Produces only a ballpark estimate of ks
◼ More suitable for SMEs that are private companies
Dr. Siri Chutikamoltham
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 If the results vary with different methods,
what’s a reasonable final estimate of ks ?
1. Use the result from the method you have the most confidence in
2. If all have equal confidence, use the average
Example:
Method Estimate
CAPM 14.2%
DCF 13.8%
kd + RP 14.0%
Average 14.0%

Dr. Siri Chutikamoltham

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 Summary Pros and Cons of Different Methods
to Estimate Ks
◼ DDM:
⚫+ widely used
⚫+ can apply easily to mature stocks that pay dividend
⚫- not easy to estimate g with accuracy
⚫- not applicable to stocks that do not pay dividend
⚫- assumes constant g that may not be true in practice
⚫- does not work if g > Ks

Dr. Siri Chutikamoltham

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 Summary Pros and Cons of Different Methods
to Estimate Ks (cont)
◼ CAPM
⚫ +widely used in countries with large data base for stocks
⚫ + can use with any stocks that we can get the inputs for CAPM, with or
without dividend payment
⚫ +consistent with Risk vs Return concept
⚫ - need to choose inputs for CAPM with great care (science + art)
◼ Kd + premium
⚫ + widely used when there is no stock market data
⚫ + easy estimate
⚫ +intuitive: stock investors need higher compensation than debt holders
⚫ -highly subjective
Dr. Siri Chutikamoltham
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 Cost of New Common Equity
◼Flotation costs can be substantial: 3.15 –
13.3%, for issue 500 M USD – 10 USD*
◼The smaller the amount issued, the larger the
larger flotation cost as % of the issue
◼Must incorporate the flotation costs
◼ ks = D1/(1-F)P0 + g
◼F = flotation costs as % of the new equity
issued
* Source: Inmoo Lee, The cost of raising capital, J. of Financial Research
Dr. Siri Chutikamoltham
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 Cost of New Common Equity
◼ Example:
◼ Company A’s stock expects to pay a dividend of $1.82 per
share next year, current stock price is $32 and its growth rate is
5.4%
◼ Cost of Retained Earnings
◼ ks = D1/P0 + g
◼ = 1.82/32 +5.4% = 5.7% +5.4% = 11.1%
◼ Cost of New Common Equity if Flotation is 12.5%
◼ ks = D1/(1-F)P0 + g
◼ = 1.82/(1-0.125)x32 +5.4% = 6.5% +5.4% = 11.9%

* Source: Inmoo Lee, The cost of raising capital, J. of Financial Research

Dr. Siri Chutikamoltham
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 Cost of Preferred Equity
◼ Preferred Stock is a hybrid security.
◼ Ownership without voting right, but entitlement to
dividend payments
◼ Similar to bonds in that preferred stocks have a par value
and a fixed dividend.
◼ Similar to stocks in that many preferred stocks do not
have a maturity date, perpetual.
◼ Unlike bonds, preferred stock dividends can be skipped
at times without fear of pushing the firm into bankruptcy.
◼ However, preferred dividend must be paid before
dividends can be paid on common stock.
Dr. Siri Chutikamoltham
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 Is preferred stock more or less risky to
investors than debt?

◼ More risky or less risky, why?

◼ In the US, investors in preferred stocks are mainly

corporations because 70% of preferred dividends
are nontaxable to corporations.

Dr. Siri Chutikamoltham

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 Example: Preferred Stock Valuation
What’s the value of a preferred stock with a required
rate of return of 10% and annual dividend = $5?

◼For perpetual preferred stock, its dividend is

a perpetuity.
◼Vps = Dps/ kps
◼Vps = $5/ 0.1 = $50

Dr. Siri Chutikamoltham

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 Example: Required Rate of Return on
Preferred Stocks
What’s the return of a preferred stock with a
value of $50 and annual dividend = $5?
$5
V ps = $50 =
kˆ ps

$5
kˆ ps = = 0.10 = 10.0%.
$50

kps = Dps/Vps
Dr. Siri Chutikamoltham
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 Plan Ahead

◼Read Ch.7
◼Individual assignment: Problem Set Cost of
Equity
◼Due before next class

Dr. Siri Chutikamoltham

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