Financial management

This query is : Resolved

rishabh (Querist)
Follow

16 February 2014 Equity shares are quoted at ₹130 per share and a new issue is proved at ₹125 per share will be fully subscribed, floation cost ₹5per share. Than in calculation of cost of eqity which price we will consider and in calculation of cost of reserve which price of we will consider and why???

rishabh

rishabh (Querist)
Follow

16 February 2014 Plz answer

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
Follow

24 July 2024 When calculating the cost of equity and cost of reserves in the context of equity shares, the prices considered depend on the purpose of the calculation and the specific components involved. Here’s how each is typically determined:

### Cost of Equity:

The cost of equity represents the return that shareholders expect to earn from their investment in the company's equity shares. There are various methods to calculate the cost of equity, one common approach being the Dividend Discount Model (DDM) or the Capital Asset Pricing Model (CAPM).

**Price Consideration:**
- **Market Price for Existing Shares:** For existing equity shares that are actively traded on the stock exchange (quoted at ₹130 per share in your case), the market price is used to calculate the cost of equity. This price reflects the current valuation by the market and is relevant because it indicates the return expected by investors who buy shares at this price.

- **New Issue Price:** The new issue price of ₹125 per share is relevant for determining the cost of equity only if it represents the expected return that new shareholders anticipate from purchasing the new shares. However, typically, for existing shareholders and for the calculation of the overall cost of equity, the market price of existing shares (₹130 per share) is more commonly used.

### Cost of Reserves:

The cost of reserves refers to the cost or opportunity cost associated with retaining earnings rather than distributing them to shareholders as dividends. It's used in scenarios where a company retains earnings to fund growth or other investments.

**Price Consideration:**
- **No Direct Impact of Issue Price:** The issue price of the new shares (₹125 per share) does not directly impact the calculation of the cost of reserves. The cost of reserves is not related to the issuance price of new shares but rather to the potential return that shareholders could have received if those earnings were distributed as dividends.

- **Conceptual Basis:** The cost of reserves is often considered in terms of the return shareholders could earn if those retained earnings were distributed as dividends and they invested elsewhere. It’s an opportunity cost rather than a direct financial calculation based on share issuance prices.

### Conclusion:

- **Cost of Equity:** Use the market price of existing shares (₹130 per share) when calculating the cost of equity, as it reflects the return expected by shareholders who currently own shares in the company.

- **Cost of Reserves:** The cost of reserves is not directly influenced by the issue price of new shares (₹125 per share). It’s conceptualized as the opportunity cost of retained earnings that could have been distributed as dividends.

In summary, for cost of equity calculations, use the market price of existing shares (₹130 per share) as it reflects investor expectations. The issue price of new shares (₹125 per share) is relevant primarily for assessing the success of the new share issuance and its associated costs.

Upgrade to CAclubindia Pro. Subscribe Now!