Eile Edit View History Bookmarks Iools Help Aplia: Student Question C Chegg Stud

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Eile Edit View History Bookmarks Iools Help Aplia: Student Question C Chegg Study IGuided Solu x CengageBrain My Home ii courses aplia.com/af/servlet/quiz?cto syildiz-0005&quiz; action takeQuiz&quiz; probGuid QNAPcoA801010000002e8c44a0080000&ck; 1 1460846993683 oAAA0559014F7497449EC4F30000 5. The cost of retained earnings Aa Aa 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 4.2%. The market risk premium is 5.7%. Allen Co. has a beta of 0.87. Using the Capital Asset Pricing Model (CAPM) approach, Allen's cost of equity is The cost of equity using the CAPM approach Kuhn Co. is closely held and, consequently, cannot generate reliable inputs for the CAPM approach. Kuhn's bonds yield 10.2%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4.5%. Using the bond-yield-plus-risk-premium approach, find the firm's cost of equity: O 16.2% O 14.0% O 17.6% O 14.7% The cost of equity using the Discounted Cashflow (or Dividend Growth) Approach Kirby Co.'s stock is currently selling for $25.67, and the firm expects its dividend to be $1.38 in one year. Analysts cost of equity? O 15.8% O 12.0% O 17.0% O 12.6% Estimating growth rates 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 Kirby is currently distributing 50.00% of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 8.00%. Kirby's estimated growth rate is 58:44 Timeout 5:51 P

Explanation / Answer

If a firm cannot invest retained earnings to earn a rate of return higher than the required rate of return on retained earnings, it should return those funds to its shareholders. Using the CAPM Approach, Allen's Cost of Equity is (5.7% - 4.2%) X 0.87 = 1.31% Using the bond-yield-plus-risk-premium approach, Kuhn Co's Cost of Equity is 10.2% + 4.5% = 14.7% Using the discounted cash flow approach, Kirby Co's cost of equity is = $ 25.67 / ($ 1.38 X 107.2%) = 17.00% Kirby's estimated growth rate is 8% + 50% of 8% = 12%.

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