The earnings, dividends, and common stock price of Shelby Inc. are expected to g

Question

The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 5% per year in the future. Shelby's common stock sells for $22.25 per share, its last dividend was $1.60, and the company will pay a dividend of $1.68 at the end of the current year.

Using the discounted cash flow approach, what is its cost of equity? Round your answer to two decimal places.
%

If the firm's beta is 2.0, the risk-free rate is 6%, and the expected return on the market is 14%, then what would be the firm's cost of equity based on the CAPM approach? Round your answer to two decimal places.
%

If the firm's bonds earn a return of 9%, and analysts estimate the market risk premium is 3 to 5 percent, then what would be your estimate of rs using the over-own-bond-yield-plus-judgmental-risk-premium approach? Round your answer to two decimal places. (Hint: Use the midpoint of the risk premium range).
%

On the basis of the results of parts a through 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.
%

Explanation / Answer

Last Dividend=$1.60

Next Dividend=$1.60*1.05=$1.68

Current Price=$22.25

Cost of Equity=(D1/P0)+G

=($1.68/$22.25)+5

=12.55%

2. CAPM

Cost of Equity=Rf+beta(Rm-Rf)

=6%+(2*8)= 22%

3. Estimated Cost=9%+4%=13%

(Average Premium=(3+5)/2=4)

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