True or False: It is free for a company to raise money through retained earnings
ID: 2615343 • Letter: T
Question
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 (Rr) is 3.86%, while the market risk premium is 6.63%. the Wilson Company has a beta of 0.92. Using the Capital Asset Pricing Model (CAPM) approach, Wilson'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 11.52%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4.95%. Based on the bond-yield-plus-risk-premium approach, Jackson's cost of internal equity is: ? 20.59% ? 15.65% ? 16.47% ? 18.12% The cost of equity using the discounted cashflow (or dividend growth) approach Tucker Enterprises's stock is currently selling for $45.56 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 Tucker's cost of internal equity? 8.75% 11.81% 9.19% 10.94% ? ?Explanation / Answer
The Cost of Equity using the CAPM Approach
Cost of Equity under CAPM Approach = Rf + [ Beta x Risk Premium ]
= 3.86% + [ 0.92 x 6.63% ]
= 3.86% + 6.10%
= 9.96%
The cost of Equity using the Bond Yield plus risk premium approach
Cost of Equity = Bond’s Yield + Risk Premium
= 11.52% + 4.95%
= 16.47%
The Cost of Equity using the Discounted Cash Flow Approach
Under Discounted Cash Flow Approach,
P0 = D1 / [ Ke – g ]
Here, P0 [Market Price] and G[Growth Rate] are given in the question. Therefore, by using the above formula, we can calculate the cost of Equity [Ke] which is as calculated as follows ;
$45.56 = $1.35 / [Ke – 0.0572]
[Ke – 0.0572] = 0.0303
Therefore, Cost of Equity[Ke]
= 0.0303 + 0.0572
= 0.0875 or
= 8.75%
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