Asked by Deonna Hershey-Kisses on May 10, 2024
Verified
Chambliss Inc.hired you as a consultant to help estimate its cost of capital.You have been provided with the following data: D0 = $0.90; P0 = $27.50; and g = 8.00% (constant) .Based on the DCF approach,what is the cost of equity from retained earnings?
A) 10.41%
B) 10.96%
C) 11.53%
D) 12.11%
DCF Approach
The Discounted Cash Flow (DCF) approach is a valuation method used to estimate the value of an investment based on its expected future cash flows, adjusted for the time value of money.
Cost of Equity
The return a company theoretically pays to its equity investors to compensate them for the risk of investing in the company's stock.
Retained Earnings
The portion of net income not distributed as dividends but retained by the company to reinvest in its core business or to pay debt.
- Compute the equity cost employing various methodologies, including DCF and CAPM.
Verified Answer
MM
Matthew MorelliMay 12, 2024
Final Answer :
C
Explanation :
We can use the dividend growth model to estimate the cost of equity from retained earnings.
Cost of Equity (ks) = (DS1 / PS1) + g
Where:
DS1 = expected dividends per share next year
PS1 = current market price per share
g = expected constant growth rate of dividends
DS1 = DS0 * (1 + g) = $0.90 * (1 + 0.08) = $0.972
ks = ($0.972 / $27.50) + 0.08 = 0.1173 or 11.73%
Therefore, the closest answer choice to 11.73% is C) 11.53%.
Cost of Equity (ks) = (DS1 / PS1) + g
Where:
DS1 = expected dividends per share next year
PS1 = current market price per share
g = expected constant growth rate of dividends
DS1 = DS0 * (1 + g) = $0.90 * (1 + 0.08) = $0.972
ks = ($0.972 / $27.50) + 0.08 = 0.1173 or 11.73%
Therefore, the closest answer choice to 11.73% is C) 11.53%.
Learning Objectives
- Compute the equity cost employing various methodologies, including DCF and CAPM.