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Flashcards in Topic 8 Deck (7)
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The following all mean the same thing:

- Required return
- __________
- Cost of capital

Appropriate discount rate


The cost of capital depends primarily on the use of the funds, not the _________.



Advantages and disadvantages of the approach Dividend Model

Advantages are to be easy to understand, and easy to use

Disadvantages: company has to pay dividends, cost of equity is very ________ to the estimated growth rate



Advantages and disadvantages of the approach SML

Two advantages: first, it explicitly adjusts for risk. Second, it is applicable to companies other than just those with steady dividend growth

Drawbacks: The SML approach requires that two things be estimated, the ________ and the beta coefficient. To the extent that our estimates are poor, the resulting cost of equity will be inaccurate.

Moreover, as with the dividend growth model, we essentially rely on the past to predict the future when we use the SML approach. Economic conditions can change very quickly, so, as always, the past may not be a good guide to the future.

market risk premium


According to the ________ dividend growth model:
Re = D1/ P + g
where: Re = the required return on shares



Dividend Growth Model Approach

+ Advantages
- Easy to use
- Easy to understand

+ Disadvantages
- Only applicable to companies paying dividends
- Assumes dividend growth is ______.
- Cost of equity is very sensitive to growth estimate.
- Ignores risk.



The SML Approach

+ Advantages
- Adjusts for risk
- Accounts for companies that don’t have a constant dividend

+ Disadvantages
- Requires estimate of _____
- Uses the past to predict the future