COMSATS University Islamabad, Lahore Campus

Department of Management Sciences

Quiz 1 – Semester fall-2021

Course Title: Financial Management Course Code: MGT-330 Credit Hours: 3(3,0)
Course Instructor/s: Program Name: BSBA
Semester: 5th Batch: FA19 Session: Time 30 Minutes
Total Marks: 10 Obtained Marks: Date: Oct 15,, 2021
Student’s Name: Reg. No.

Note: Attempt the questions carefully, and follow all the steps

Question 1:

Descon Corporation has a target capital structure of 40% debt and 60% common equity, with no
preferred stock. Its before-tax cost of debt is 12%, and its marginal tax rate is 40%. The current
stock price is P0 =$22.50. The last dividend was D0= $2.00, and it is expected to grow at a 7%
constant rate. What is its cost of common equity and its WACC? (5)
Question 2:
If a firm has to calculate its cost of common equity. What common methods are used
mostly. Write the formula , and explain what is difference in the cost of retained earning
and Issuing New common stock. ( 5)

Cost of Equity is the rate of return a company pays out to equity investors. A firm uses cost of
equity to assess the relative attractiveness of investments, including both internal projects and
external acquisition opportunities. Companies typically use a combination of equity and debt
financing, with equity capital being more expensive.
How to Calculate Cost of Equity
The cost of equity can be calculated by using the CAPM (Capital Asset Pricing Model) or
Dividend Capitalization Model (for companies that pay out dividends).
CAPM (Capital Asset Pricing Model)
CAPM takes into account the riskiness of an investment relative to the market. The model is less
exact due to the estimates made in the calculation (because it uses historical information).
CAPM Formula:
E(Ri) = Rf + βi * [E(Rm) – Rf]
 Where:
E(Ri) = Expected return on asset i
Rf = Risk-free rate of return
βi = Beta of asset i
E(Rm) = Expected market return
Dividend Capitalization
The Dividend Capitalization Model only applies to companies that pay dividends, and it also
assumes that the dividends will grow at a constant rate. The model does not account for
investment risk to the extent that CAPM does (since CAPM requires beta).
Dividend Capitalization Formula:
Re = (D1 / P0) + g
 Where:
Re = Cost of Equity
D1 = Dividends/share next year
P0 = Current share price
g = Dividend growth rate
 
Question 2:
What are the alternate Methods of Equity Financing? Define and Write their Formulas.