Corporate Finance: Cost of Equity, Asset Beta, Dividend Ratios

CORPORATE FINANCE

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY..................................................................................................................................3
a) Calculation of current cost of equity of Next Plc. using Capital Asset Pricing Model
(CAPM).......................................................................................................................................3
b) Calculation of Asset Beta of Next Plc.....................................................................................5
c) Different forms of dividend ratio.............................................................................................7
(D) Suitable investment appraisal technique...............................................................................9
CONCLUSION..............................................................................................................................11
REFERENCES................................................................................................................................1

INTRODUCTION
Next Plc. is an UK based retail sector company which offers the various products such as
cloths, footwear, beauty, accessories and home products. The main purpose and objectives of the
company is to provide the unique and in trend along with the high in quality products to their
local and international customers. This is an international retail company which have around 199
stores via franchise all over the 32 countries. The company have many segments in which one id
Next Finance which provide credit service to the customers so that they can buy the product
online and from stores in next pay. This report will state the cost of equity of the Next Plc. using
the CAPM model and also their asset beta. The report will also discuss the dividend policy of
Next Plc. over the past 5 years.
MAIN BODY
a) Calculation of current cost of equity of Next Plc. using Capital Asset Pricing Model (CAPM)
Cost of equity is a return amount that an organization need to pay its equity shareholders
and investors in order to compensate the risk that is taken by shareholder to invest in their
company (Phuoc, Kim and Su, 2018). In order to calculate the cost of equity of the company
using the capital asset pricing model the following formula need to be used:
Formula, Ke = rf + βe × (Rm - Rf)
Where, Ke = cost of equity
rf = Risk-Free Rate
βe= Equity beta
Rm= Expected returns of the market
In order to calculate βe (equity beta), the following formula need to be used:
Equity Beta(βe) = Covariance A, B/ Variance A
Where, A = 5 years daily returns of the FTSE100
And B = 5 years daily returns of the stock Next Plc.
Here, in the give case the following data is available related to Next Plc. Plc
Ke = cost of equity
rf = Risk-Free Rate = 0.778%
βe= Equity beta = 1.0896

Rm= Expected returns of the market = 3.86% (2021)
So, the cost of equity of the Next Plc. are as follow:
Ke = 0.00778 + 1.0896* (0.0386 – 0.00778)
= 0.041357
Explanation and Justification of data used:
 In order to calculate the cost of equity using the CAPM model, the risk-free rate of the
stock of the Next Plc. have been used. A risk-free rate is basically rate of return of the
stocks which has zero risk and no risk at all. In real world, such type of securities does
not exist because every type of security has some kind of the risk attack with it. For
example, US treasury bill is considered as a risk-free asset because it is hold, backed and
managed by the government of the US. This data is a part of the cost of equity calculation
using the capitalized assets price modelling (Baker, Kumar and Pattnaik, 2021).
 Another data used to calculate the COE is include equity beta and this is one of the
important measures of the CAPM model as it helps in evaluating the expected return of
stocks. The equity beta is basically depending upon the debts and leverage of the
company. In case, if Next Plc. have no debts than their equity beta and asset beta will be
equal but if there is presence of the debt than equity and asset beta will be unequal.
Whenever the amount of the debt of the Next Plc. increases, its equity beta will also
increase which reflect the direct relationship between the two variables (Zaman and et.al.,
2019).
 The expected return of the market is also one of the most important data used to calculate
the Ke because this is a forecast of the market’s return over the specific period of time.
The expected return of the FTSE100 market is 8.95% in the year 2021. But as this is a
forecast and estimation, so it is not important that it reflect accurate data all the time. The
accuracy of CAPM result is basically depends upon the ability of the experts to predict
the variable over the period of time. On an average, the investors and company expect at
least 15 to 20% and this also considered as good in stock market. So, the return of UK
market is not good as it shown (Yuan and Wen, 2018).
 Further to calculate the ke the company and investors also need to use the data related to
the FTSE100 and Next Plc. 5-year daily return. 5-year returns of the both FTSE100 and