The correct answer is: D. None of the above
The cost of equity is the rate of return that a company must earn on its equity capital in order to satisfy its investors. It is a measure of the riskiness of a company’s equity, and it is used to calculate the company’s weighted average cost of capital (WACC).
The Net Income Approach is one method of estimating the cost of equity. It is based on the idea that the cost of equity is equal to the expected return on a company’s equity, which is equal to the company’s expected dividend yield plus its expected capital gains yield.
The expected dividend yield is the expected annual dividend per share divided by the current share price. The expected capital gains yield is the expected increase in the share price over the next year, expressed as a percentage.
The Net Income Approach is a relatively simple method of estimating the cost of equity, but it is not always accurate. This is because it assumes that the company’s dividend yield and capital gains yield will remain constant over time. However, these yields can change significantly, depending on the company’s performance and the overall market conditions.
For a more accurate estimate of the cost of equity, it is often better to use a more sophisticated method, such as the Capital Asset Pricing Model (CAPM). The CAPM takes into account the company’s riskiness, as measured by its beta coefficient, and the risk-free rate of return.
The cost of equity is an important concept in corporate finance. It is used to calculate the WACC, which is used to evaluate investment projects and to determine the company’s optimal capital structure.