Why must a cost be assigned to retained earnings?
What three approaches are used to estimate the cost of common equity?
Identify some problems with the CAPM approach.
Which of the two components of the DCF formula, the dividend
yield or the growth rate, is more difficult to estimate? Why?
What’s the logic behind the bond-yield-plus-risk-premium approach?
Suppose you are an analyst with the following data: rRF 5.5%; rM
rRF 6%; b 0.8; D1 $1.00; P0 $25.00; g 6%; rd firm’s bond
yield 6.5%. What is this firm’s cost of equity using the CAPM, DCF,
and bond-yield-plus-risk-premium approaches? Use the mid-range of
the judgmental risk premium for the bond-yield-plus-risk-premium
approach. (CAPM 10.3%; DCF 10%; Bond yield RP 10.5%
