Assume you have researched the following financial data: (1): r d = yield on the

Question

Assume you have researched the following financial data:

(1): rd = yield on the firm%u2019s bonds = 7.00% and the risk premium over its own debt cost = 4.00%.

(2) rRF = 5.00%, RPM = 6.00%, and b = 1.25.

(3) D1 = $1.20; P0 = $35.00 and g = 8.00% (constant).

Estimate the cost of equity based on the three most commonly used methods, and then to indicate the difference between the highest and lowest of these estimates. What is cost of equity according to each method and what is that difference between the highest and lowest estimates?

Explanation / Answer

1) 7+4 = 11%

2) cost of equity = 5+1.25*6 = 12.5%

3) r = 1.2/35)+.08 = 11.42%

highest is cost of equity method = 12.5%

lowest is method no 1 = 11%

difference = 1.5%

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