The cost of retained earnings:
If a firm cannot invest retained earnings to earn a rate ofreturn_______________the required rate of return on retainedearnings, it should return those funds to its stockholders.
The cost of equity using the CAPM approach:
The current risk-free rate of return (rRFrRF) is 4.67% while themarket risk premium is 5.75%. The D’Amico Company has a beta of0.78. Using the capital asset pricing model (CAPM) approach,D’Amico’s cost of equity is ______________ .
The cost of equity using the bond yield plus risk premiumapproach:
The Taylor Company is closely held and, therefore, cannotgenerate reliable inputs with which to use the CAPM method forestimating a company’s cost of internal equity. Taylor’s bondsyield 11.52%, and the firm’s analysts estimate that the firm’s riskpremium on its stock over its bonds is 3.55%. Based on thebond-yield-plus-risk-premium approach, Taylor’s cost of internalequity is:
14.32%
15.07%
18.84%
16.58%
The cost of equity using the discounted cash flow (or dividendgrowth) approach
Johnson Enterprises’s stock is currently selling for $32.45 pershare, and the firm expects its per-share dividend to be $2.35 inone year. Analysts project the firm’s growth rate to be constant at5.72%. Estimating the cost of equity using the discounted cash flow(or dividend growth) approach, what is Johnson’s cost of internalequity?
17.50%
13.61%
12.31%
12.96%
Estimating growth rates:
It is often difficult to estimate the expected future dividendgrowth rate for use in estimating the cost of existing equity usingthe DCF or DG approach. In general, there are three availablemethods to generate such an estimate:
| • | Carry forward a historical realized growth rate, and apply itto the future. |
| • | Locate and apply an expected future growth rate prepared andpublished by security analysts. |
| • | Use the retention growth model. |
Suppose Johnson is currently distributing 45% of its earnings inthe form of cash dividends. It has also historically generated anaverage return on equity (ROE) of 14%. Johnson’s estimated growthrate is _________%.
