Question

True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders. O False True The cost of equity using the CAPM approach The current risk-free rate of return (rf) is 4.23%, while the market risk premium is 6.63%. the Roosevelt Company has a beta of 0.78. Using the Capital Asset Pricing Model (CAPM) approach, Roosevelt's cost of equity is The cost of equity using the bond yield plus risk premium approach The Lincoln Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company's cost of internal equity. Lincoln's bonds yield 10.28%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Lincoln's cost of internal equity is: O 16.60% 13.14% 17.29% 13.83% The cost of equity using the dividend valuation model approach Johnson Enterprises's stock is currently selling for $32.45 per share, and the firm expects its per-share dividend to be $2.35 in one year. Analysts project the firm's growth rate to be constant at 7.27%. Using the cost of equity using the dividend valuation model approach, what is Johnson's cost of internal equity? 13.78% 14.51% O 19.59% 18.14%

Answer 1

1)

False

Internal earnings have a cost associated to it.

2)

Cost of equity = Risk free rate + beta(market risk premium)

Cost of equity = 4.23% + 0.78(6.63%)

Cost of equity = 4.23% + 5.1714%

Cost of equity = 9.40%

2)

Cost of internal equity = Bond yield + risk premium

Cost of internal equity = 10.28% + 3.55%

Cost of internal equity = 13.83%

3)

Cost of internal equity = (D1 / price) + growth rate

Cost of internal equity = (2.35 / 32.45) + 0.0727

Cost of internal equity = 0.1451 or 14.51%