Financial management :Cost of capital 资本成本 (二)

1. Capital asset pricing model (CAPM)

Equity risk premium=Rm－Rf

Assumptions:

Well diversified investors/ perfect capital market/ unrestricted borrowing or lending at the risk free rate of interest/ Uniformity of investor expectations/ All forecasts are made in the context of one time period.

If an investment is riskier than average, then beta is more than 1, and vice-versa.

2. Asset beta and equity beta

Asset beta: it reflects the systematic risk of the business area.

Equity beta: it reflects the systematic risk of the business area and the company specific gearing ratio.(measure both business risk and financial risk)

Geared company involves both business and financial risk, whereas ungeared company involves only business risk.

Asset beta=Equity beta×MVe/[MVe＋MVd(1－t)]

3. Cost of debt

Preference share: Kpref =Dividend/Po

Dividend has no tax benefit, since it is paid from profit after tax

Po: ex-div market value of the share

Interest is paid from profit before interest and tax