What Factors Affect the Cost of Common Equity?

Calculation of common stock capital costs

Common stock cost

Calculation of common stock capital costs

The formula for calculating the cost of funds for common stock is:

Kc = dc / Pc (1-f) + G

among them:

Kc--cost ratio of common stock funds;

Dc--dividend on the total amount of common shares issued in the first year;

Pc-total amount of common shares;

f--funding rate;

G--Common Stock Dividend Expected Annual Growth Rate

Chinese name

Common stock cost

Foreign name

Cost of Common Stock

Nature

Equity Finance

The cost of common stock funds is the necessary return on investment. It is the discount rate that makes the total value of future dividend income of common stocks converted to the present value equal to the current price of common stocks.

G--Common stock dividends are expected to grow annually.

[Example] An enterprise issues 10 million yuan of common stock at face value, with a funding rate of 4%, a dividend rate of 12% in the first year, and an annual increase of 5% in the future. Then the capital cost of this common stock is: Kc = (1000 × 12%) / 1000 × (1-4%) + 5% = 17.5%

The cost of common stock capital approach

Dividends paid by the company to ordinary shareholders are affected by the company's after-tax profits and dividend distribution policies. Therefore, the common stock dividend is generally a variable, and its cost of capital is difficult to determine. There are three common methods:

Discounted dividend model

Capital asset pricing model

Risk premium model

Discounted dividend model

Calculated according to the idea that the cost of capital is essentially the necessary return on investment for shareholders. The basic model is:

K c is the cost of capital of common stock, that is, the necessary return on investment of common stock shareholders;

D t is the dividend for the t-th year of the ordinary shares;

P c is the amount of financing for the issue of common stock

f c is the financing cost ratio

This model will vary depending on the dividend testimony

2. Capital asset pricing model

If the company adopts a fixed dividend policy, the calculation of the cost of capital ratio is similar to the calculation of the cost of capital of preferred shares;

If the company adopts a fixed growth dividend policy, the calculation model of the cost of capital ratio is as follows:

K c is the cost of capital for common stock

D 1 Ordinary future total dividends of the first period (), D 0 is the previous dividend

P c Total funding for common stock

F c common stock financing expense ratio

g Annual growth rate of common stock dividends

Capital asset pricing model

K c = R F + ( R M R F )

3. Risk premium model

According to the principle of "the greater the risk, the higher the required return rate", the return rate of the stock should be added to the bond return rate plus a certain risk premium, as shown below:

K C = K b + RP c

RPc is the risk premium required for ordinary shareholders to bear greater risks than creditors, generally between 3-5% ^[1]