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Cost of Equity and Cost of Debt is a cost of raising the finance by equity or debt but it actually a required return to shareholders?
As compared to cost of equity and cost of debt what is actually TSR (Total shareholder return)? I know that it takes the dividend + change in share price over the year.
What is the difference between Cost of Equity and TSR? And am I correct about what I mentioned above?
The cost of equity and debt are relevant for calculating the WACC so that we can appraise projects.
The shareholders required rate of return is determined by looking at their expectations of future dividends.
The total shareholder return is looking at what their return was over the past year. That may not be the return that they require in the future.
1) BUT is it correct that the cost of equity & debt is a cost to a company but it is a required return to investors??
2) Is there any effect on the risk-free rate and market premium in the CAPM model if there is an increase in the prevailing interest rate?
3) Is there any inclusion of tax in the CAPM model?
1. The cost of equity to the company is the same as the shareholders required rate of the return. The cost of debt to the company is not the investors required rate of the return – the cost to the company is lower because of the tax relief on the debt interest.
2. If interest rates increase then the risk free rate will be higher and so will the return from the market.
3. Not when calculating the cost of equity using the beta. However tax is relevant when gearing and ungearing betas as you can see from the formula.
All of this is explained in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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