Question

Big Time Corp. is trying to determine their cost of equity. You would like to use 3 different approaches. Given the following information, calculate the cost of equity according to the CAPM approach , Bond Yield plus Risk Premium approach, and the Discounted Cashflow approach:

• Current risk-free return is 3.86%

• Market risk premium is 5.75%

• Beta is 0.92

• Bond yield is 10.28%

• The firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4.95%

• Their stock is currently selling for $32.45 per share

• The firm expects to pay a per-share dividend of $1.38 in one year

• Analysts project the firm's growth rate will be a constant 5.72%

**Hints for the 3 Approaches:**

**(1) CAPM Approach: rs = Rf + Betai(market risk
premium)**

**(2) Bond-Yield-Plus-Risk-Premium Approach: rs = Bond
Yield + Risk premium**

**(3) Discounted Cash Flow (DCF) Approach: rs = D0 * [(1 +
g)/P0] + g**

Answer #1

The cost of equity using the CAPM approach
1) The current risk-free rate of return (rRFrRF) is 4.67% while
the market risk premium is 5.75%. The Jefferson Company has a beta
of 0.92. Using the capital asset pricing model (CAPM) approach,
Jefferson’s cost of equity is __________ .
The cost of equity using the bond yield plus risk premium
approach
2) The Jackson Company is closely held and, therefore, cannot
generate reliable inputs with which to use the CAPM method...

Quantitative Problem: Barton Industries
estimates its cost of common equity by using three approaches: the
CAPM, the bond-yield-plus-risk-premium approach, and the DCF model.
Barton expects next year's annual dividend, D1, to be
$2.20 and it expects dividends to grow at a constant rate g = 3.6%.
The firm's current common stock price, P0, is $22.00.
The current risk-free rate, rRF, = 4.8%; the market risk
premium, RPM, = 6.1%, and the firm's stock has a current
beta, b, = 1.2....

Barton Industries estimates its cost of common equity by using
three approaches: the CAPM, the bond-yield-plus-risk-premium
approach, and the DCF model. Barton expects next year's annual
dividend, D1, to be $1.90 and it expects dividends to
grow at a constant rate g = 5.2%. The firm's current common stock
price, P0, is $25.00. The current risk-free rate,
rRF, = 4.5%; the market risk premium, RPM, =
6.2%, and the firm's stock has a current beta, b, = 1.35. Assume
that...

Quantitative Problem: Barton Industries
estimates its cost of common equity by using three approaches: the
CAPM, the bond-yield-plus-risk-premium approach, and the DCF model.
Barton expects next year's annual dividend, D1, to be
$1.80 and it expects dividends to grow at a constant rate g = 5.9%.
The firm's current common stock price, P0, is $30.00.
The current risk-free rate, rRF, = 5%; the market risk
premium, RPM, = 6.3%, and the firm's stock has a current
beta, b, = 1.1....

4. The cost of retained earnings
If a firm cannot invest retained earnings to earn a rate of
return the required rate of return on retained
earnings, it should return those funds to its stockholders.
The cost of equity using the CAPM approach
The current risk-free rate of return (rRFrRF) is 4.67% while the
market risk premium is 5.75%. The Burris Company has a beta of
1.56. Using the capital asset pricing model (CAPM) approach,
Burris’s cost of equity is ...

4. The cost of retained earnings
If a firm cannot invest retained earnings to earn a rate of
return (greater than or equal to, Less than) the required rate of
return on retained earnings, it should return those funds to its
stockholders.
The cost of equity using the CAPM approach
The current risk-free rate of return (rRFrRF) is 3.86% while the
market risk premium is 6.63%. The D’Amico Company has a beta of
0.78. Using the capital asset pricing model...

The cost of retained earnings
If a firm cannot invest retained earnings to earn a rate of
return_____________ (less than or greater than or equal
to) the required rate of return on retained earnings, it
should return those funds to its stockholders.
The cost of equity using the CAPM approach
The current risk-free rate of return (rRFrRF) is 4.67% while the
market risk premium is 5.75%. The D’Amico Company has a beta of
0.78. Using the capital asset pricing model...

10-6 COST OF COMMON EQUITY The future earnings, dividends, and
common stock price of Callahan Technologies Inc. are expected to
grow 6% per year. Callahan's common stock currently sells for
$22.00 per share; its last dividend was $2.00; and it will pay a
$2.12 dividend at the end of the current year.
a. Using the DCF approach, what is its cost of common
equity?
b. If the firm's beta is 1.2, the risk-free rate is 6%, and the
average return...

1.) The cost of raising capital through retained earnings is
__________ (greater than, less than) the cost of
raising capital through issuing new common stock.
2.) The current risk-free rate of return is 3.80% and the
current market risk premium is 6.10%. Blue Hamster Manufacturing
Inc. has a beta of 1.56. Using the Capital Asset Pricing Model
(CAPM) approach, Blue Hamster’s cost of equity is __________
(13.99%, 17,32%, 14.65%, 13.32%)
3.) Fuzzy Button Clothing Company is closely held and, as...

Which of the following statements about cost-of-equity
estimation is most correct?
A
The CAPM approach is always superior to the DCF approach.
B
The risk premium used in the debt-cost-plus-risk-premium
approach is the same as the risk premium used in the CAPM
approach.
C
Because the CAPM and DCF approaches use market data, they
provide precise cost-of-equity estimates.
D
The debt-cost-plus-risk-premium approach can be used when the
business does not have publicly traded equity.
E
All approaches always produce estimates...

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