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1) The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital
1) The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm's bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.50. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference?
2) The general ledger of Sandhill Corporation as of December 31, 2021, includes the following accounts:
Copyrights $ 46000
Deposits with advertising agency (will be used to promote goodwill) 23000
Discount on bonds payable 66000
Excess of cost over fair value of identifiable net assets of
Acquired subsidiary 440000
Trademarks 80000
In the preparation of Sandhill's balance sheet as of December 31, 2021, what should be reported as total intangible assets?
Expert Solution
1) Computation of the cost of equity using yield on bonds & risk premium:-
Cost of equity = Yield on bond + Risk premium
= 7.00% + 4.00%
= 11.00%
Computation of the cost of equity using CAPM:-
Cost of equity = Risk free rate + (Beta * Market risk premium)
= 5.00% + (1.50 * 6.00%)
= 5.00% + 9.00%
= 14.00%
Computation of the cost of equity using dividend growth model:-
Cost of equity = (D1 / P0) + Growth rate
= ($1.20 / $35) + 8.00%
= 3.43% + 8.00%
= 11.43%
Computation of the difference between the highest & lowest cost of equity:-
Difference = Cost of equity using CAPM - Cost of equity using yield on bond & risk premium
= 14.00% - 11.00%
= 3.00%
2) Computation of the amount should be reported as intangible assets:-
Total intangible assets = Copyrights + Acquired subsidiary + Trademarks
= $46,000 + $440,000 + $80,000
= $566,000
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