498 WordsOct 5, 20112 Pages

Meaning- Cost of equity
A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership.
Cost of equity is a component of overall cost of capital of the firm. Cost of capital is the minimum return firm has to generate from its business. It is easy to calculate cost of capital for the firm rather than for its divisions. The reason for the same is that funds are raised by the firms not by the divisions. Risk associated with the divisions can be different from the risk owned by firm’s business alone. If this is true required return for the divisions will be different from the return generated by the firm.
Article- Finnigan Corporation
In the above article business is divided in two divisions The Instruments and Disc subsidiary and raised capital by one-third of debt and two-third from equity.
Firm cost of capital is 14.5 %, which is the weighted average of cost of debt (Rd=4.4%) and cost of equity (Re=19.4%)
Rd= .092(1-.52) = 4.4%
Re = .06 + (.13 - .06) 1.7 + .015 = 19.4%.
Rd+e = .33 (.044) + .67 (.194) = 14.5%
In practice, division operated by the firms have different risk so required rate of return for them is also different because of different cost of capital than firm.
Divisional betas are calculated by pure play approach in which we find the proxy companies operates solely into the same product in which the firm’s division operates and then takes the average of betas of all the proxy companies, but it is very difficult to identify similar company with a same single product also sometime division can be more riskier than proxy company because of its operating risk so it may be chance that beta value determined by proxy companies does not reflect true picture for the division as in this article. Capital structure for both the division is assumed to be same

Related

## Behavioral Asset Pricing Essay

6662 Words | 27 PagesBehavioral Asset Pricing Seminar Paper to be presented at the Behavioural Finance-Workshop Supervisor: Prof. Dr. Jens Carsten Jackwerth Oliver Feix Peter-Rosegger-Weg 23 78464 Konstanz 24.06.2002 Contents 1 Introduction 2 The Eﬃcient Market Hypothesis 3 Does the EMH (Still) Hold? 3.1 The Bad News for the EMH Supporters . . . . . . . . . . . . . . . . 3.2 The Good News for (and of) EMH Supporters . . . . . . . . . . . . 4 Behavioral Asset Pricing: A Way Out? 5 Behavioral Asset Pricing and Practical

## The Capital Asset Pricing Model Essay

826 Words | 4 PagesThe Capital Asset Pricing Model A widely accepted …nancial model for estimating the cost of equity capital is the Capital Asset Pricing Model (CAPM). In this model, the cost of equity capital (or the expected return) is determined by the systematic risk a¤ecting the …rm. The mathematical formula underlying the model is r = rf + (rm ¡ rf )¯; where r is the expected return on the …rm’s equity, rf is the risk-free rate, rm is the expected return on the overall market portfolio, and ¯ is the equity

## Chapter 7—Risk, Return, and the Capital Asset Pricing Model Essay

4952 Words | 20 PagesChapter 7—Risk, Return, and the Capital Asset Pricing Model MULTIPLE CHOICE 1. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following four risky portfolios should she hold in combination with a position in the risk-free asset? a. portfolio with a standard deviation of 15% and an expected return of 12% b. portfolio with a standard deviation of 19% and an expected return of 15% c. portfolio with a standard deviation of 25% and an expected return of 18% d. portfolio with

## Pricing Models Essay

764 Words | 4 PagesAbstract Understanding option pricing and value is critical to becoming a successful trader. When buying or selling options, there is a system used in the market by which the market gives a price for any option. An option is a security that gives its owner the right to trade in a fixed number of shares of common stock at a fixed price at any time on or before a given date. There are several pricing models used to determine the fair market value of the options ("Option valuation," 2013). This

## Black Scholes Pricing Model Essay

697 Words | 3 PagesFinancial Management Black-Scholes Pricing Model There’s several ways for pricing options, the Black-Scholes pricing model and Binomial pricing model, these two for the most part are common of the pricing options. The first model to be developed was the Black-Scholes model. This model is math based and mostly based on different suppositions and impractical. It’s unable to give the value of options on share paying stocks; the Binomial estimates are effective in solving this problem, by using

## The Appropriateness of the Capm as an Asset Pricing Model Essay

617 Words | 3 Pagesthe CAPM, as an asset pricing model Introduction The problem of estimating the cost of capital asset, or the return expected by shareholders, is one of the most debated issues in the context of the Financial Theory. The different estimation models, produced in order to develop a theory of the cost of capital have found extensive discussion in the literature, feeding the debate on both hand theoretical and the empirical. An important contribution to the evolution of these models is due to Harry

## Oil Pricing Model Essay

4048 Words | 17 Pages………………………………………………………………………………………………………………………………. 1 Dependent Variable……………………………………………………………………………………………………………………..1 Independent Variable…………………………………………………………………………………………………………………..3 Full Model……………………………………………………………………………………………………………………………………4 Developing a Model…………………………………………………………………………………………………………………….7 Final Preferred Models, Model Interpretation and Summary …………………………………………………….19 Appendix-1………………………………………………………………………………………………………………………………..22 Appendix-2………………………………………………………………………………………………………………………………

## Asset Pricing with Liquidity Risk Essay

17811 Words | 72 PagesARTICLE IN PRESS Journal of Financial Economics 77 (2005) 375–410 www.elsevier.com/locate/jfec Asset pricing with liquidity risk$ Viral V. Acharyaa,b, Lasse Heje Pedersenb,c,d,Ã London Business School, Regent’s Park, London, NW1 4SA, UK b Center for Economic Policy Research, UK c Stern School of Business, New York University, 44 West Fourth Street, Suite 9-190, New York 10012, USA d National Bureau of Economic Research, USA Received 6 January 2003; received in revised form 4 May 2004; accepted

## Asset Pricing Chapter 6 Essay

2292 Words | 10 Pagesthe bond if long-term interest rates increase during the year. If Treasury bond yields rise above 9%, then the price of the bond will fall, and the resulting capital loss will wipe out some or all of the 9% return you would have earned if bond yields had remained unchanged over the course of the year. 5. a. If businesses reduce their capital spending, then they are likely to decrease their demand for funds. This will shift the demand curve in Figure 5.1 to the left and reduce the equilibrium real

## Capital Asset Pricing Model Essay

659 Words | 3 PagesCapital Asset Pricing Model One of the most important things to remember in finances, is that return is a function of risk. Which basically means that the more risk you take the higher your potential return should be to offset your increase chance of loss. One of the many tools used by finance professionals to calculate the return an investment should bring is the Capital Asset Pricing Model (CAPM). CAPM was introduced by Harry Markowitz, Jack Treynor, John Lintner, Jan Mossin

### Behavioral Asset Pricing Essay

6662 Words | 27 Pages### The Capital Asset Pricing Model Essay

826 Words | 4 Pages### Chapter 7—Risk, Return, and the Capital Asset Pricing Model Essay

4952 Words | 20 Pages### Pricing Models Essay

764 Words | 4 Pages### Black Scholes Pricing Model Essay

697 Words | 3 Pages### The Appropriateness of the Capm as an Asset Pricing Model Essay

617 Words | 3 Pages### Oil Pricing Model Essay

4048 Words | 17 Pages### Asset Pricing with Liquidity Risk Essay

17811 Words | 72 Pages### Asset Pricing Chapter 6 Essay

2292 Words | 10 Pages### Capital Asset Pricing Model Essay

659 Words | 3 Pages