Question

The equity capital is cost free. Do you agree? Give reasons.

Answer 1

It is sometimes argues that the equity capital is free of cost. The reason for such argument is that it is not legally binding for firms to pay dividends to ordinary shareholder. Further, unlike the interest rate or preference dividend rate, the requital to be free of cost. Equity capital involves an opportunity cost; ordinary shareholders supply funds to the firm in the expectation of dives’s the market value of the share in the expectation of dividends and capital gains commensurate with their risk of investment. The market value of the share determined by the demand and supply forces in well fractioning capital market reflects the return required by ordinary, shareholder. Thus, the shareholder’s repaired with the return, which equates the present value of the expected dividends with the market enquiry would, however be more than the shareholder’s market price of the share.

Answer 2

Answer:

No, equity capital is not cost free.

Explanation:

Some economists and financial experts contend that equity capital is cost-free. This argument stems from the fact that companies are not required by law to pay dividends to common shareholders.

Additionally, unlike interest rates or preference dividend rates, the equity dividend rate is not set in stone. Therefore, assuming equity capital is cost-free is incorrect.

Equity capital obviously has an opportunity cost, and regular shareholders contribute money in the hope of receiving dividends (along with capital gains) proportionate to the risk of their investment.

The market price of the shares, which is established by supply and demand in a healthy and effective capital market, indicates the required rate of return for common shareholders.

The cost of equity capital is therefore given by the shareholder's needed rate of return, which is equal to the present value of the anticipated dividends and the share's market value.

However, if the share's issued price differs from its market price, the cost of external equity might not match the shareholder's necessary rate of return.