Problem 9-10 *** A and B are already correct*** Cost of Equity The earnings, div
ID: 2659773 • Letter: P
Question
Problem 9-10
***A and B are already correct***
Cost of Equity
The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 4% per year in the future. Shelby's common stock sells for $24.50 per share, its last dividend was $2.50, and the company will pay a dividend of $2.60 at the end of the current year.
The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 4% per year in the future. Shelby's common stock sells for $24.50 per share, its last dividend was $2.50, and the company will pay a dividend of $2.60 at the end of the current year. Using the discounted cash flow approach, what is its cost of equity? If the firm's beta is 2.0, the risk-free rate is 4%, and the expected return on the market is 14%, then what would be the firm's cost of equity based on the CAPM approach? If the firm's bonds earn a return of 10%, and analysts estimate the market risk premium is 3 to 5 percent, then what would be your estimate of rs using the over-own-bond-yield-plus-judgmental-risk-premium approach? (Hint: Use the midpoint of the risk premium range). On the basis of the results of parts a through c, what would be your estimate of Shelby's cost of equity? Assume Shelby values each approach equally.
Explanation / Answer
rs = rd + Judgmental risk premium midpoint of the risk premium range = 4% n rs = 10.0% + 4% = 14%4. estimate of Shelby's cost of equity = (14.61% + 14%)/2 = 14.31%