Question

Attempts: Average: 15 S. The cost of retained earnings The cost of retained earnings The cost of raising capital through retained earings is the cost of raising capital through issuing new common stock. The cost of equity using the CAPM approach The yield on a three-month T-bills 39, the yield on a 10-year T-bond is 3.67%, the market risk premium beta of 0.B0. Using the Capital Asset Pricing Model (CAPM) approach, Wilson's cost of equity is 6.97% and the Wilson Company has a The cost of equity using the bond yield plus risk premium approach in contrast, the Adams Company is closely held and therefore, cannot generate reliable inputs with which to apply the CAPM method to estimate its cost of internal equity (retained earnings). However, its management knows that its outstanding bonds are currently yielding 8.429, and the firm's analysts estimate that the risk premium of its stocks over its bonds is currently 1.48%. As result, Adars's cost of internal equity ()-based on the own-bond-yield-plus-judgemental-risk-premium approach-Is: 10.89% 11.899 9.90% 9.40% The cost of equity using the discounted cash flow (or dividend-yield-plus-growth-rate) approach Tucker Enterprises's stock is currently selling for $18.75 per share, and the firm expects its per share dividend to be $3.75 in one year. Analysts project the firm's growth rate to be constant at 5.00%. Using the discounted cash flow (or dividend yield-plus-growth rate) approach, what is Tuckers cast of Internal equity? MacBook Pro

Answer 1

1). The cost of raising capital through retained earnings is less than the cost of raising capital through new capital. (Explanation: Cost of retained earnings is less as there are no underwriter costs, etc. associated with it.)

2).Wilson's cost of equity (using CAPM) = risk-free rate + beta*(market return - risk-free rate)

= 3.67% + 0.8*(6.97%-3.67%) = 6.31% (Risk-free rate is the yield on long term government bonds.)

3). Adams' cost of internal equity = bond yield + risk premium = 8.42% + 1.48% = 9.90%

4). Tuckers' cost of internal equity = (next year's dividend/current price) + growth rate

= (3.75/18.75) + 5.80% = 25.80%

5). Tucker's growth rate = ROE*retention rate = ROE*(1-dividend rate) = 10.50%*(1-60%) = 4.20%