Question

Problem 9-10 Cost of Equity The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 6% per year in the future. Shelby's common stock sells for $22.50 per share, Its last dividend was $1.50, and the company will pay a dividend of $1.59 at the end of the current year. 2. Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places the firm's beta is 1.7. the risk-free rate is 8%, and the expected return on the market is 12%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places C h ef's bonds earn a return of 129, then what would be your estimate of using the over-own-bond-yield-plus-judgmental-risk-premium approach Round your answer to two decimal places. Chint: Use the midpoint of the risk premium range.) d. On the basis of the rest of parts a through what would be your estimate of Shelby's cost of equity? Assume Shelby values each approach ul. Round your answer to two decimal places Check se Work (3 remaining)

Answer 1

a). According to the DCF;

kE = [D1 / P0] + g = [$1.59 / $22.50] + 0.06 = 0.0707 + 0.06 = 0.1307, or 13.07%

b). According to the CAPM,

kE = Risk-free Rate + [Beta*(Expected market return - Risk-free rate)]

= 8% + [1.7 * (12% - 8%)]

= 8% + [1.7 * 4%] = 8% + 6.8% = 14.8%

c). Assume the range of risk premium be 3%-5%

Average Risk Premium = [3% + 5%] / 2 = 4%

According to the Bond-yield-plus-judgmental-risk-premium;

kE = Bond Yield + Risk Premium = 12% + 4% = 16%

d). According to the 3 estimates,

kE = [16.07% + 14.8% + 16%] / 3 = 43.87% / 3 = 14.62%