What is Cost of Equity? – Meaning, Concept and Formula
February 12, 2025
They say that there is no smoke without fire. This is true of many things and one of them is asset bubbles. It is true that all asset bubbles begin their initial upward movement based on some genuinely good positive news. However, somewhere along the way, the amount of smoke far exceeds the underlying fire […]
Book building has been one of the most widely used methods in the underwriting process. However, over the years, companies have realized that the book-building process is largely controlled by the intermediaries, i.e., the investment banks! The investment banks are the ones building the books. Hence, they can easily control who gets in and at […]
The traditional financial theory assumes that all investors are rational. Hence, they believe that all investors will reach the exact same conclusion with regard to investment decisions. However, we see evidence of the opposite happening in the marketplace. Even if different people have the same information, they tend to process the information differently and come […]
The Indian banking system is reeling under a glut of Non Performing Assets (NPA’s). The unpaid debts of Indian corporations and households have risen to alarming levels. High level bureaucratic meetings are being held to get rid of this menace. Nonperforming assets could appear on the balance sheet of banks. This could cause a ripple […]
The press releases by the United States oil companies will have you believe that fracking is the best thing that has been discovered since “fire”! The newspapers are full of praise for the new technique and how it is likely to bring back the glorious days when America was self-reliant with regards to energy. However, […]
Corporate finance is based on two fundamental rules. All tools and techniques of corporate finance are mere ways and means of implementing these rules. These rules can be found at the beginning of any and every corporate finance text book. One of these rules relates to the concept of return while the other relates to the concept of risk. We have described both these rules in this article. They are as follows:
The fundamental rule of corporate finance is that the timing of cash flows is of paramount importance. Also, we want the timing of the cash flows to be as soon as possible. The sooner we get the cash, the better it is for our company. Every dollar that the company has in cash today is better than the same dollar in cash tomorrow because of the following reasons:
Corporate finance involves exchanging between present and future streams of cash flows. Companies may come across different projects which offer different future cash flows. However, it is important to realize that all cash flows are not equally likely to materialize in the future. Some cash flows may be almost certain like investing in treasury bonds while others may be highly uncertain like projected returns from stock market investments. Hence, the second rule states that the company must adjust each of these cash flows for their risk before making any comparisons and selections. The following factors must be considered:
The bottom line is that before making a choice, all projects have to be made comparable. This is done by adjusting for cash flow that will be received in different time periods as well as adjusting for the different amounts of risks that are involved in different projects.
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