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The cost of external equity can be most appropriately computed as per the
- a)earnings price ratio
- b)dividend price ratio
- c)dividend price plus growth ratio
- d)capital asset pricing model
Correct answer is option 'D'. Can you explain this answer?
Most Upvoted Answer
The cost of external equity can be most appropriately computed as per ...
The Capital Asset Pricing Model (CAPM) is a model that describes the relationship between the expected return and risk of investing in a security. The cost of external equity can be most appropriately computed as per the capital asset pricing model. It shows that the expected return on a security is equal to the risk-free return plus a risk premium, which is based on the beta of that security.
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The cost of external equity can be most appropriately computed as per ...
The Cost of External Equity
The cost of external equity is a critical financial metric for companies seeking to raise capital through the issuance of new shares. Among various methods, the Capital Asset Pricing Model (CAPM) stands out as a preferred approach.
Understanding CAPM
- CAPM calculates the expected return on equity based on risk.
- It incorporates the risk-free rate, the equity's beta (a measure of volatility relative to the market), and the market risk premium.
Key Components of CAPM
- Risk-Free Rate: This is typically the return on government securities, indicating a baseline return without risk.
- Beta: Represents the sensitivity of the stock’s returns to changes in overall market returns. A beta greater than one indicates higher volatility compared to the market.
- Market Risk Premium: The additional return expected by investors for taking on the risk of investing in stocks over risk-free assets.
Why CAPM is Preferred
- Focus on Risk: It effectively captures the risk-return trade-off, making it a suitable choice for assessing the cost of equity.
- Market Efficiency: Assumes that markets are efficient, and thus the stock price reflects all available information.
- Versatility: Applicable across various industries and adaptable to changing market conditions.
Conclusion
Using the Capital Asset Pricing Model (CAPM) provides a comprehensive framework for firms to estimate the cost of external equity based on inherent risks and market conditions, making it the most appropriate method in this context.
The cost of external equity is a critical financial metric for companies seeking to raise capital through the issuance of new shares. Among various methods, the Capital Asset Pricing Model (CAPM) stands out as a preferred approach.
Understanding CAPM
- CAPM calculates the expected return on equity based on risk.
- It incorporates the risk-free rate, the equity's beta (a measure of volatility relative to the market), and the market risk premium.
Key Components of CAPM
- Risk-Free Rate: This is typically the return on government securities, indicating a baseline return without risk.
- Beta: Represents the sensitivity of the stock’s returns to changes in overall market returns. A beta greater than one indicates higher volatility compared to the market.
- Market Risk Premium: The additional return expected by investors for taking on the risk of investing in stocks over risk-free assets.
Why CAPM is Preferred
- Focus on Risk: It effectively captures the risk-return trade-off, making it a suitable choice for assessing the cost of equity.
- Market Efficiency: Assumes that markets are efficient, and thus the stock price reflects all available information.
- Versatility: Applicable across various industries and adaptable to changing market conditions.
Conclusion
Using the Capital Asset Pricing Model (CAPM) provides a comprehensive framework for firms to estimate the cost of external equity based on inherent risks and market conditions, making it the most appropriate method in this context.
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The cost of external equity can be most appropriately computed as per thea)earnings price ratiob)dividend price ratioc)dividend price plus growth ratiod)capital asset pricing modelCorrect answer is option 'D'. Can you explain this answer?
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The cost of external equity can be most appropriately computed as per thea)earnings price ratiob)dividend price ratioc)dividend price plus growth ratiod)capital asset pricing modelCorrect answer is option 'D'. Can you explain this answer? for UGC NET 2025 is part of UGC NET preparation. The Question and answers have been prepared according to the UGC NET exam syllabus. Information about The cost of external equity can be most appropriately computed as per thea)earnings price ratiob)dividend price ratioc)dividend price plus growth ratiod)capital asset pricing modelCorrect answer is option 'D'. Can you explain this answer? covers all topics & solutions for UGC NET 2025 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for The cost of external equity can be most appropriately computed as per thea)earnings price ratiob)dividend price ratioc)dividend price plus growth ratiod)capital asset pricing modelCorrect answer is option 'D'. Can you explain this answer?.
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