Cost of Equity The earnings, dividends, and common stock price of Shelby Inc. ar
ID: 2777593 • Letter: C
Question
Cost of Equity
The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 5% per year in the future. Shelby's common stock sells for $29.50 per share, its last dividend was $1.80, and the company will pay a dividend of $1.89 at the end of the current year.
Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places.
%
If the firm's beta is 2.0, the risk-free rate is 3%, and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places.
%
If the firm's bonds earn a return of 9%, 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? Round your answer to two decimal places. (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. Round your answer to two decimal places.
Explanation / Answer
Cost of Equity
The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 5% per year in the future. Shelby's common stock sells for $29.50 per share, its last dividend was $1.80, and the company will pay a dividend of $1.89 at the end of the current year.
Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places.
Cost of equity = Expected Dividend/Current Share Price + growth rate
Cost of equity = 1.89/29.50 + 5%
Cost of equity = 11.41%
If the firm's beta is 2.0, the risk-free rate is 3%, and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places.
As per CAPM
cost of equity = risk-free rate + ( expected return on the market - risk-free rate )*beta
cost of equity = 3% + (13%-3%)*2
cost of equity = 23%
If the firm's bonds earn a return of 9%, 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? Round your answer to two decimal places. (Hint: Use the midpoint of the risk premium range).
Estimate of rs = -bond-yield + judgmental-risk-premium
Estimate of rs = 9% + (3%+5%)/2
Estimate of rs = 13%
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. Round your answer to two decimal places.
cost of equity = 11.41% *1/3+ 23%*1/3 + 13%*1/3
cost of equity = 15.80%