Chapter 10 • Cost of capital estimations and the discount rate
The value of the lease at the date of its being taken out is the cost of the asset that is
the subject of the lease. Since this figure and the amount and timing of the future lease
payments can be discovered, kcan be discovered. To identify the present cost of a lease
later in its life we should need to take a similar attitude to that which is necessary in
respect of term loans and unlisted loan notes. We could try to put some current value
on the lease and solve for kin the valuation expression (equation (10.2) above). We
could, however, assume that the current opportunity cost of the lease finance is more
or less the same as it was when the lease was first taken out.
Trying to value the lease at some date after it has been in operation for a while is
likely to be a fairly difficult task, so we are probably left with making the assumption
that the interest rate implied by the original contract is still appropriate. Alternatively,
some estimate of rates applying to current new leases could be used.
Assessing the cost of using hire purchase to provide part of the finance is achieved
in much the same way as with financial leases.Preference shares
The calculation of the cost of preference shares is almost identical to that for loan
notes. The major differences between the two financing methods are as follows:l Interest on loan notes attracts corporation tax relief; preference dividends do not.
l Loan interest is paid under a contractual obligation; preference dividends are paid
at the discretion of the business’s directors.
The first point simply means that tax should be ignored in the calculation of the
cost of preference shares. The second implies that rather more uncertainty is involved
with predicting preference dividends than with predicting loan interest payments,
although this creates no difference in principle.Ordinary shares
Ordinary shares too are similar to loan notes in the basic calculation of the cost of
capital. Ordinary shares have a value because they are expected to yield dividends.
How, if at all, the pattern of dividends affects the value of equities, we shall discuss in
Chapter 12.Ex dividend and cum dividend
Before we start detailed discussion of dividends and how they are linked to share
prices, a few words need to be said about the basis on which shares are traded in the
secondary capital market. Normally, shares are traded cum dividend, which means
that anyone who buys the shares will receive the next dividend paid by the business
concerned. When a dividend is imminent, the business concerned will ‘close’ its list of
shareholders and pay the dividend to those shareholders appearing on the list, in
other words the shares go ex dividend. This means that anyone buying the shares after
that date will not receive that particular dividend; it will, however, be paid to the pre-
vious shareholders who have sold their shares since the close date. This is despite the
fact that those investors will no longer own the shares on the dividend payment day.
Not surprisingly, the price of the share falls, by the value of the forthcoming dividend,
as the share moves from being traded cum dividend to being traded ex dividend.‘
‘