If a firm cannot invest retained earnings to earn a rate of return the required

Question

If a firm cannot invest retained earnings to earn a rate of return the required rate of return on retained earnings, it should return those funds to its stockholders. The current risk-free rate of return is 4.6%. The market risk premium is 6.6%. Allen Co. has a beta of 0.87. Using the Capital Asset Pricing Model (CAPM) approach, Allen's cost of equity is Kuhn Co. is closely held and, consequently, cannot generate reliable inputs for the CAPM approach. Kuhn's bends yield 10.2%, and the firm's analysts estimate that the firm's risk premium on its stock over its bends is 3.5%. Using the bond-yield-plus-risk-premium approach, find the firm's cost of equity: 17.1% 13.0% 15.1% 13.7% 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 7.2%. Using the discounted cash flow (DCF) approach, what is Turnbull's cost of equity? 18.0% 14.4% 13.7% 15.1% It is often difficult to estimate the expected future dividend growth rate for use in estimating the cost of existing equity using the DCF or DG approach. In general, there are three available methods to generate such an estimate: Carry forward a historical realized growth rate, and apply it to the future. Locate and apply an expected future growth rate prepared and published by security analysts. Use the retention growth model. Suppose Turnbull is currently distributing 45.00% of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 24.00%. Turnbull's estimated growth rate is

Explanation / Answer

1)

greater than or equal to

2)

Cost of equity using CAPM approach = risk free rate + beta ( market risk premium)

cost of equity = 0.046 + 0.87 ( 0.066)

cost of equity = 0.10342 or 10.342%

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