The earnings, dividends and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby's common stock sells for $23 per share, its last dividend was $2.00 and the company will pay a dividend of $2.14 at the end of the current year.
(a) Using the discounted cash flow approach what is the cost of equity? (Answer is 16.3%-show all work and formulas)
(b) If the firm’s beta is 1.6, the risk free rate is 9% and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach?
(c) If the firm's bonds earn a return of 12% then what would be your estimate of rs using the own bond yield plus judgement risk premium approach? (Hint use the midpoint of the risk premium range).
(d) On the basis of the results of parts a through c what would be your estimate of Shelbys cost of equity?