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Chapter 17

The cost of capital

Outcome

By the end of this session you should be able to:

 explain the relationship between risk and return in financial investments

 explain the nature and features of different securities in relation to the risk/return
trade-off

 explain the relative risk/return relationship of debt and equity and the effect on
their relative costs

 describe the creditor hierarchy and its connection with the relative costs of
sources of finance

 calculate cost of equity using the DVM and be able to discuss its weaknesses

 calculate dividend growth using the dividend growth model (DGM)

 define and distinguish between systematic and unsystematic risk

 explain the relationship between systematic risk and return and describe the
assumptions and components of the capital asset pricing model (CAPM)

 use the CAPM to find a company’s cost of equity

 explain and discuss the advantages and disadvantages of the CAPM

 calculate the cost of finance for irredeemable debt, redeemable debt,
convertible debt, preference shares, and bank debt

 define and distinguish between a company’s average and marginal cost of
capital

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