1. The current risk-free rate of return is 4.67%, while the market risk premium
ID: 2811740 • Letter: 1
Question
1. The current risk-free rate of return is 4.67%, while the market risk premium is 5.75%. the wilson company has a beta of 1.56. using the capital asset pricing model approact, wilsons cost of equity is: a. 16.37% b. 13.64% c. 15.00% d. 14.32%
2. The Adams Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a companys cost of internal equity. Adam's bonds yield 10.28%, and the firms analysts estimate that the firms risk premium on its stock over its bonds is 5.89. Based on the bond-yield-plus-risk-premium approach, Adams cost of internal equity is: a. 19.40% b. 17.79% c. 15.36% d. 16.17%
3. Suppose Kirby is currently distributing 40.00 of its earnings in the form of cash dividends. It has also historically generated an average return on equity of 8.00. Kirby's estimated growth rate is: a. 68.00 b. 7.40 c. 4.80 d. 8.60
Explanation / Answer
Answer 1.
Risk-free Rate = 4.67%
Beta = 1.56
Market Risk Premium = 5.75%
Cost of Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Equity = 4.67% + 1.56 * 5.75%
Cost of Equity = 13.64%
Answer 2.
Bond Yield = 10.28%
Risk Premium = 5.89%
Cost of Internal Equity = Bond Yield + Risk Premium
Cost of Internal Equity = 10.28% + 5.89%
Cost of Internal Equity = 16.17%
Answer 3.
Payout Ratio = 0.40
Retention Ratio, b = 1 - Payout Ratio
Retention Ratio, b = 1 - 0.40
Retention Ratio, b = 0.60
Growth Rate = ROE * b
Growth Rate = 8.00% * 0.60
Growth Rate = 4.80%
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