FIN 010 Chapter Notes - Chapter 4: Capital Asset Pricing Model, Capital Structure, Retained Earnings
Document Summary
Remember, we are trying to measure a single company"s cost of equity capital, and this will be affected by the external and internal variables mentioned above. We know beta is an indicator of the riskiness of a product vis- -vis the wide market: accordingly, equity costs can be set as a function of beta, risk-free rate, and return on the market. While there are no fees associated with retained earnings because they are generated by post-tax / post-dividend earnings, they incur capital costs that are usually set equal to the common stock costs. That strategy is acceptable because if a corporation does not have any retained profits, it would have to issue common stock to fund its balance sheet: a business faces no single equity capital bill. Through recognizing that a firm faces a problem, we can generalize total costs. This process is primarily focused on discounting potential dividends, which we know to reflect the earning power of a business.
