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The earnings, dividends, and stock price of Shelby Inc
The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 8% per year in the future. Shelby's common stock sells for $21 per share, its last dividend was $1.00, and the company will pay a dividend of $1.08 at the end of the current year.
a. Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places. 11.4 e % b. If the firm's beta is 1.5, the risk-free rate is 9%, and the expected return on the market is 12%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places. 12
c. If the firm's bonds earn a return of 10%, then what would be your estimate of rs using the own-bond-yield-plus-judgmental-risk-premium approach? (Hint: Use the mid-point of the risk premium range.) Round your answer to two decimal places. 13
d. On the basis of the results of parts a-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. 12.71 'k4.) %
Expert Solution
a) Computation of Cost of Equity using Discounted Cash Flow Approach:
Cost of Equity = (Dividend to be paid / Current Stock Price) + Growth Rate
= ($1.08 /$21) + 8%
= 13.14%
b) Computation of Firm's Cost of Equity using CAPM Approach:
Cost of Equity = Risk-free Rate + Beta * (Expected Return on Market - Risk-free Rate)
= 9% + 1.5 * (0.12 - 0.09)
= 13.50%
c) Computation of Cost of Equity using the own-bond-yield-plus-judgmental-risk-premium approach:
= 10% + 4% (Since the range of risk premium normally fluctuates between 3% to 5%, therefore 4% has been assumed as midpoint )
= 14%
d) Computation of Cost of Equity using Equally Approach:
= (13.14% + 13.50% + 14%) / 3
= 13.55%
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