Calculating Cost of Equity
Hi,
Bit new to all this and just looking for some help with a problem I have, which relates to determining whether a company should finance an expansion in a new market using equity or debt. Information I have about the company includes current share price, market capitalisation, P/E, ROE, Dividend Yield, etc. I also have revenue for the past 12 months, as well as projected revenue (which is expected to increase).
I am just wondering how I can use this information to determine the actual cost of issuing new shares from the company's perspective. I have tried using a method in a corporate finance textbook, which suggests that I determine the plowback ratio (earnings put back into the company), and then use the ROE to determine the equity growth rate. I can then add the equity growth rate to the dividend yield to determine the expense of the equity from the company's perspective.
However this method just doesn't seem too clever, particularly if I have the revenue growth. Can I not somehow use this information to determine what the future cost of the equity will be to the company?
As a side note, is it not generally better to issue debt compared to equity anyway if you don't have a very high leverage ratio? The interest rate on debt is quite small, and you wouldn't be sacrificing your future profits.
Thanks for the help.
1 / P/E Ratio + dividend yield
Thanks for the info.
However I have come across another formula which suggests I should use dividend yield and P/E to get the plowback ratio. Then use this with the ROE to get the equity growth rate, and add this to the dividend yield.
Any chance you could explain which method is better in this case? Both seem to make sense to me. Thanks.
Valuation is an art, not a science. Just go with whatever you feel can justify easier.
Valuation is the input, cost of equity is just one of the outputs.
This is not true. How do you determine how much you should pay for something?
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