5 The cost of retained earnings Aa Aa True or False It is fr

5. The cost of retained earnings Aa Aa 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. False True The cost of equity using the CAPM approach The current risk-free rate of return (Rp) is 3.86%, while the market risk premium is 5.75%, the Jefferson Company has a beta of 0.78. 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 The Jackson 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. Jackson\'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, Jackson\'s cost of internal equity is: ? 13.14% ? 13.83% ? 15.21% ? 17.29%

Solution

1)(False) Company needs funds for expansion and diversification. In order to generate funds, companies can either borrow loan from bank or use its own resources.(Retained Earnings). 2) Risk Free rate 3.86% Market risk premium 5.75% Beta 0.78 Cost of Equity=Risk Free Rate+Beta*(Market Risk Premium) 3.86%+0.78*(5.75%) Cost of Equity= 8.35% 3) Jackson\'s cost of internal equity Bond Yield+Risk Premium=(10.28%+3.55%) 13.83% Jackson;s cost of internal equity=13.83% 4) (Dividend/Current Selling Price)+Growth Dividend $                             2.35 Current selling price $                           25.67 Growth 5.72% (2.35/25.67)+5.72% 14.87% Kirby\'s cost of internal equity=14.87%