True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders. True False
True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders. True False
Financial Reporting, Financial Statement Analysis and Valuation
8th Edition
ISBN:9781285190907
Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Chapter5: Risk Analysis
Section: Chapter Questions
Problem 2QE
Related questions
Question
True or False: It is free for a company to raise money through retained earnings , because retained earnings represent money that is left over after dividends are paid out to shareholders.
True
False
The cost of equity using the CAPM approach
The current risk-free rate of return (rRFrRF) is 4.23% while the market risk premium is 6.17%. The Burris Company has a beta of 0.78. Using the capital asset pricing model (CAPM) approach, Burris’s cost of equity is .
The cost of equity using the bond yield plus risk premium approach
The Jackson Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Jackson’s bonds yield 10.28%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Jackson’s cost of internal equity is:
13.83%
16.60%
13.14%
15.21%
The cost of equity using the discounted cash flow (or dividend growth) approach
Tucker Enterprises’s stock is currently selling for $45.56 per share, and the firm expects its per-share dividend to be $2.35 in one year. Analysts project the firm’s growth rate to be constant at 5.72%. Estimating the cost of equity using the discounted cash flow (or dividend growth) approach, what is Tucker’s cost of internal equity?
10.88%
11.42%
10.34%
13.60%
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 Tucker is currently distributing 70% of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 18%. Tucker’s estimated growth rate is %.
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Follow-up Question
True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders.
True
False
The cost of equity using the CAPM approach
The current risk-free rate of return (rRFrRF) is 4.23% while the market risk premium is 6.17%. The Burris Company has a beta of 0.78. Using the capital asset pricing model (CAPM) approach, Burris’s cost of equity is .
The cost of equity using the bond yield plus risk premium approach
The Jackson Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Jackson’s bonds yield 10.28%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Jackson’s cost of internal equity is:
13.83%
16.60%
13.14%
15.21%
The cost of equity using the discounted cash flow (or dividend growth) approach
Tucker Enterprises’s stock is currently selling for $45.56 per share, and the firm expects its per-share dividend to be $2.35 in one year. Analysts project the firm’s growth rate to be constant at 5.72%. Estimating the cost of equity using the discounted cash flow (or dividend growth) approach, what is Tucker’s cost of internal equity?
10.88%
11.42%
10.34%
13.60%
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 Tucker is currently distributing 70% of its earnings in the form of cash dividends. It has also historically generated an average return on equity (ROE) of 18%. Tucker’s estimated growth rate is %.
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