Promoting Entrepreneurship Education Through Valuation of Cost of Equity

Promoting Entrepreneurship Education Through Valuation of Cost of Equity

Olabanji Oni (University of Fort Hare, South Africa) and Prince Sivalo Mahlangu (University of Fort Hare, South Africa)
Copyright: © 2021 |Pages: 27
DOI: 10.4018/978-1-7998-3171-6.ch015
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This chapter provided an extensive discussion on promoting entrepreneurship education using capital asset pricing model (CAPM) and Gordon dividend discount Model in the valuation of cost of equity. Researchers have debated on the valid model for valuation cost of equity capital. There are two main models that can be used in the valuation of cost of equity capital; these are CAPM and the Gordon dividend discount model. The Gordon dividend discount model proposed by Myron Gordon is grounded on conventional assumptions. Gordon dividend discount model is built around the future value of dividends expected by the company's shareholders in line with the anticipated growth rate provided. However, CAPM sets its estimation of determining the expected return of a single asset on beta coefficient (β), which is difficult to predict. Predicting of β is based on a company's historical returns and the model asserts that historical returns of a company's stock can help in determining the future return of that stock. Practically, this is undoubtedly difficult to ascertain.
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Part One

Part one of the chapter provides a discussion on the concept Capital Asset Pricing Model, benefits of CAPM to entrepreneurs and investors, Assumptions of CAPM, derivation of CAPM, components of CAPM, criticism of CAPM, the Concept Gordon Dividend Discount model and the derivation of Gordon Dividend Discount model.

Capital Asset Pricing Model

Bodie, Kane and Marcus (2011) define CAPM as a set of calculations concerning equilibrium on the rate of return of risky assets. This model is regarded as an equilibrium asset-pricing model (Dawson, 2015) and further, Mahrivandi, Noviyanti and Setyanto (2017) assert that, this theory was formulated to probe the connection between risk and return of an investment, and how the dimension of risk can be minimised through diversification and a combination of the various investment instruments in a given portfolio. Portfolio management scholar Henry Markowitz laid down the foundation of the development of the model, through his work in 1952. Sharpe (1964), Lintner (1965) and Mossin (1966) further developed the CAPM, 12 years after Markowitz initial undertaking. This initially shows that it took CAPM a period of 12 years to gestate.

Key Terms in this Chapter

Beta Coefficient: This is a used to measure the volatility in the price of security when compared to the return on the market. Also referred to as the covariance of the return on return of the security and return on the market.

Weighted Average Cost of Capital (Referred to as WACC): This is the weighted average rate of return of ordinary shares, preference shares, and debt.

Gordon Dividend Discount Model: Is one of the ways that considers dividend paid when calculating the cost of equity.

Cost of Equity: Also known as the cost of ordinary shares or common stock. This is the required return from equity.

Capital Asset Pricing Model (Referred to as CAPM): Is a method that considers risk when calculating the cost of equity. It shows relationship between systematic risks and expected return on equity.

Cost of Capital: This is the price it will cost a business to raise capital using ordinary shares, preference shares and debt.

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