# Individual Cost Of Capital-Common Stocks(Part1of2)

There are two means of getting finance from common stocks namely:

• Retained earnings or internal common equity(Ke)
• External common equity (Kne)- the issuance of NEW common stocks.

Let’s see how we can compute the aforesaid’s cost of capital

 Methods To Compute Of Cost Of INTERNAL Common Equity Dividend Growth Model Capital Asset Pricing Model (CAPM) Dividend Growth Model The value of common stock is equal to the PRESENT VALUE OF EXPECTED FUTURE DIVIDENDS, discounted at the stockholders’ required rate of return Formula is Po = D1/(Ke-g) Where Po = price of the stock today D1= dividend at the end of the first year Ke= required rate of return on equity g = constant growth rate of dividends If dividends are paid at a constant annual rate of growth(g) which is less than Ke: Ke= Dividend in year 1/Market price + Annual growth rate in dividends Therefore Ke(Required rate of return)= D1/Po + g Illustration Using the DIVIDEND GROWTH MODEL BASIS Company XYZ Ltd’s recently received \$0.15 dividend per share and expect dividends to growth at an annual rate of 10%. The market price of the security is \$3, compute the investors’ required rate of return using the Dividend Growth Model: Suggested Solution: Ke( Required rate of return) = D1/Po + g = \$0.15(1+0.1) / \$3 + 0.1 = \$0.165/3+0.1 =0.155 =15.5%  