Cost of Equity | Dividend Growth Model | Corporate Finance | CPA Exam BAR | CMA Exam | Chp14 p1

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The cost of capital depends primarily on the use of the funds, not the source.
Advantages and Disadvantages of the Approach
The Securities market Line (SML) approach has two primary advantages. First, it explicitly adjusts for risk. Second, it is applicable to companies other than just those with steady dividend growth. Thus, it may be useful in a wider variety of circumstances.

There are drawbacks, of course. The SML approach requires that two things be estimated: the market risk premium and the beta coefficient. To the extent that our estimates are poor, the resulting cost of equity will be inaccurate. For example, our estimate of the market risk premium, 7 percent, is based on about 100 years of returns on particular stock portfolios and markets. Using different time periods or different stocks and markets could result in very different estimates.
With the dividend growth model, we essentially rely on the past to predict the future when we use the SML approach. Economic conditions can change quickly; so as always, the past may not be a good guide to the future. In the best of all worlds, both approaches (the dividend growth model and the SML) are applicable and the two result in similar answers. If this happens, we might have some confidence in our estimates. We might also wish to compare the results to those for other similar companies as a reality check.