Question

Cost of Equity

The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby's common stock sells for $25.75 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year.

1. Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places.
   %
   
2. If the firm's beta is 2.0, the risk-free rate is 8%, and the expected return on the market is 14%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places.
   %
   
3. If the firm's bonds earn a return of 12%, then what would be your estimate of r_s 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.)
   %
   
4. 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.
   %

Answer 1