The current risk-free rate of return (r) is 3.86%, while the market risk premium is 6.17%. the Allen Company has a beta of 1.56. Using the Capital Asset Pricing Model (CAPM) approach, Allen\'s cost of equity is The cost of equity using the bond yield plus risk premium approach The Kennedy 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. Kennedy\'s bonds yield 10.28%, and the firm\'s analysts estimate that the firm\'s risk premium on its stock over its bonds is 5.89. Based on the bond-yield-plus-risk-premiunm approach, Kennedy\'s cost of internal equity is: ? 15.36% 20.21% 17.79% 16.17% ? The cost of equity using the discounted cashflow (or dividend growth) approach Johnson Enterprises\'s stock is currently selling for $25.67 per share, and the firm expects its per-share dividend to be $1.38 in one year. Analysts project the firm\'s growth rate to be constant at 5.72%, Using the cost of equity using the discounted cashflow (or dividend growth) approach, what is Johnson\'s cost of internal equity? ? ? 14.99% 11.66% 11.10% 13.88% Estimating growth rates It is often difficuit to estimate the expected future dividend growth rate for use in estimating the cost of existing equity using the DCF or DG approach. In general, there are three available methods to generate such an estimate . Carry forward a historical realized growth rate, and apply it to the future Locate and apply an expected future growth rate prepared and published by security analysts . Use the retention growth model. Suppose Johnson is currently distributing 50.00 of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 18.00. Johnson\'s estimated growth rate is
1.
CAPM equation:
Cost of equity = Risk-free rate + Beta x Market risk premium
Cost of equity = 3.86% + 1.56 x 6.17%
Cost of equity of Allen company = 13.4852% or 13.49%
2.
Correct option is > 16.17%
Kennedy’s Cost of internal equity = Kennedy’s bond yield + Risk premium
Kennedy’s Cost of internal equity = 10.28% + 5.89%
Kennedy’s Cost of internal equity = 16.17%
3.
Correct option is > 11.10%
Given details
#
Existing growth rate = g =
5.72%
Expected dividend = D1 = D0*(1+g) =
1.38
Expected rate = r =
?
Current stock price = P0 =
25.67
Flotation cost = f =
0.00
Formula for calculating the Expected rate:
r = (D1/(P0-f))+g = (1.38/25.67) + 5.72% =
11.10%
| Given details | # |
| Existing growth rate = g = | 5.72% |
| Expected dividend = D1 = D0*(1+g) = | 1.38 |
| Expected rate = r = | ? |
| Current stock price = P0 = | 25.67 |
| Flotation cost = f = | 0.00 |
| Formula for calculating the Expected rate: | |
| r = (D1/(P0-f))+g = (1.38/25.67) + 5.72% = | 11.10% |
Homework Sourse
