The cost of equity capital and the CAPM Essay Example | Topics and Well Written Essays - 1000 words

The cost of equity capital and the CAPM - Essay Example The three most popular methods include: dividend growth model, capital asset pricing model and the arbitrage pricing model. Dividend growth model Organizations utilize the cash generated for two purposes: they either reinvest it in the growth or new projects of the organization or pay some amount as dividend to the common stockholder. The Dividend growth model is based on this premises that a shareholder of the organization will want both dividend as well as capital appreciation while holding the stock. The cost of equity in this case can be given as (Weaver and Weston, 2004, pg.282): Where, R is the required rate of return Dcs1 is the dividend payout in year 1 Pcs is the price of the stock G is the growth rate in percentage terms One of the most important factors while calculating the required rate of return thru’ the dividend growth rate is the calculation of the growth rate, G. This is an estimated growth rate and hence special precaution needs to be taken while calculating R. The three options to estimate G are: estimation of an internal growth rate, estimation from historical growth rates or by studying the growth rates stated by the management in the annual report. Because of the trickiness in estimation of the growth rate of the stock, the dividend growth rate is rarely used for the calculation of the cost of capital. The model is simplistic in nature which makes it very adaptable to many specific situations. It is a more conservative model as compared to the other two. This model is effective in finding low PE ratios and high dividend yield stocks to be undervalued. Capital Asset pricing model (CAPM) The CAPM approach of calculating the required return of a security is based on the premise that the expected return on a stock is a function of the return of the market and the sensitivity of the return of stock to changes in return of the market. For an individual security the risk of the security can be thought of as a measure of ?. Because of dive rsification, the expected return on a security is positively related to its ?. The expected return on a security in this case can be given as: CAPM is the most widely used method to calculate the expected rate of return or the cost of capital. Some of the key assumptions on which CAPM is developed are: All investors are thinking of the same period while deciding investments Investors choose their portfolios solely on the basis of expected returns and risks Investors can borrow or lend unlimited amount of money at the risk free rate All investors are having homogenous expectations. At the same time, all investors have the required knowledge and information There are no transactional costs, taxes or restrictions on shorting a stock Investors are risk averse While CAPM is quite frequently used, it can be easily seen that most of the assumptions are very simplistic in nature and do not hold true for many cases. At the same time, another problem that the CAPM is suffering from is the cal culation of ?. While the CAPM equation suggests that ? should be forward looking, in reality, it is calculated from historical returns (Gitman, 2006, pg. 47). Still, most of the financial economists consider it as the best tool to calculate the retuired rate of return. Its validity has been proved by many studies that have indicated concurrence with

Textile Manufacturing Industry in the USA Essay

Textile Manufacturing Industry in the USA - Essay Example The major companies belonging to the textile manufacturing industry operate mills that are used for the production of textiles and various textile products by processing natural and synthetic fibers. The major companies in the global textile industry include Toray Industries in Japan, International Textile Group, WL Gore and Associates, Guilford Mills, Unifi and Mohawk Industries which are based in the United States, Hyosung in South Korea and Weiqiao Textiles which operate in China. Â  The textile manufacturing industry is mainly based on the different fibers into yarn followed by fabric and textiles. The fibers which are converted into fabric and textiles are used for fabrication into clothes and the other different artifacts. Cotton is considered as the major natural fiber that is hugely processed and treated to be used in the textile industry. The processing and treatment of cotton constitute an extensive part of the textile manufacturing industry. The textile manufacturing industry employs a number of processes involved in the fabric forming and spinning phases. The textile manufacturing industry follows complex procedures to process and treat the different natural and synthetic fibers to produce a wide range of textile goods. Different techniques using machine and hand techniques are employed in this industry. Â  The demand in the textile industry is driven by the demand of the consumers as well as the different companies operating in the garments industry. The apparel industry is the major influencer of the demand levels in the textile manufacturing industry. The demand of the consumers for furnishings like curtains and carpets also influence the demand levels in the textile manufacturing industry.