The current risk-free rate of return is 4.2%. The market risk premium is 6.6%. D

Question

The current risk-free rate of return is 4.2%. The market risk premium is 6.6%. D'Amico Co. has a beta of 0.87. Using the Capital Asset pricing model (CAPM) approach, D'Amico's cost of equity is

a. 9.9%

b. 10.4%

c. 11.9%

d. 10.9%

Kuhn CO. is closely held and, consequently, cannot generate reliable inputs for the CAPM approach. Kuhn's bonds yield 11.5%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 3%. Using the bond-yield-plus-risk-premium approach, find the firm's cost of equity:

A. 14.5%

B. 17.4%

C. 13.8%

D. 18.1%

Turnbull CO.'s stock is currently selling for 32.45, and the firm expects its dividend to be 2.35 in one year. Analysts project the firm's growth rate to be constant at 5.7%. Using the discounted cash flow (DCF) approach, what is Turnbull's cost of equity?

A. 16.1%

B. 17.4%

C. 12.9%

D. 12.3%

Suppose turnbull is currently distributing 70.00% of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 12.00%. Turnbull's estimated growth rate is

A. 42%

B. 11.70%

C. 12.30%

D. 3.6%

Please show work!!! THank you!

Explanation / Answer

1.

Cost of Equity = Risk free rate of return + (Beta * Market risk premium)

D’Amico’s Cost of equity = 4.2% + (0.87*6.6%) = 9.942% i.e. 9.9%

2.

Cost of equity = Bond yield + Risk premium = 11.5% + 3% = 14.5%

3.

Cost of equity = (Dividend / Price of share) + Growth rate

Turnbull’s cost of equity = (2.35/32.45) + 0.057 = 0.0724 + 0.057 = 0.1294 i.e. 12.9%

4.

Growth rate = retention rate * Return on Equity

Retention rate = 1 – Payout rate = 1 – 0.70 = 0.30

Growth rate = 0.30 * 12% = 3.6%

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