12-22 The earnings, dividends, and stock price of Talukdar Technologies Inc. are expected to grow at 7 percent per year in the future. Talukdar'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 its cost of retained earnings? b. If the firm's beta is 1.6, the risk-free rate is 9 percent, and the average return on the market is 13 percent, what is the firm's cost of equity using the CAPM approach? If the firm's bonds earn a return of 12 percent, what is r, using the bond- yield-plus-risk-premium approach? (Hint: Use the midpoint of the risk premium range discussed in the chapter.) C. d. Based on the results of parts (a) through (c), what would you estimate Talukdar's cost of retained earnings to be?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
On an excel Spreadsheet, do the following problem
![Cost of Retained
Earnings
12-22 The earnings, dividends, and stock price of Talukdar Technologies Inc. are
expected to grow at 7 percent per year in the future. Talukdar'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.
Using the discounted cash flow approach, what is its cost of retained
earnings?
b.
If the firm's beta is 1.6, the risk-free rate is 9 percent, and the average
return on the market is 13 percent, what is the firm's cost of equity using
the CAPM approach?
a.
C.
d.
If the firm's bonds earn a return of 12 percent, what is r, using the bond-
yield-plus-risk-premium approach? (Hint: Use the midpoint of the risk
premium range discussed in the chapter.)
Based on the results of parts (a) through (c), what would you estimate
Talukdar's cost of retained earnings to be?](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F6cf9dff6-12f1-499a-ae5e-c499eec86ad4%2F37c7db82-70bc-47ec-9db4-dca2a4a4e643%2Fq7w7qgd_processed.png&w=3840&q=75)
![Bond-Yield-Plus-Risk-Premium Approach (rs = rd + RP)
Although it is a subjective procedure, analysts often estimate a firm's cost of com-
mon equity by adding a risk premium of 3 to 5 percentage points to the before-tax
cost of debt. It is logical to think that firms with risky, low-rated, and consequently
high-interest-rate debt will also have risky, high-cost equity. Using this logic to esti-
mate the cost of retained earnings is relatively easy-we simply add a risk premium
to a readily observable debt cost. For example, Daflex's cost of equity might be esti-
mated as follows:
rs = Bond yield + Risk premium
+
Id
10.0% +
=
RP
4.0%
= 14.0%
Because the 4 percent risk premium is a judgmental estimate, the estimated value of
r, also is judgmental. Empirical work suggests that the risk premium over a firm's
own bond yield generally has ranged from 3 to 5 percentage points, so this method
is not likely to produce a precise cost of equity-about all it can do is get us "into
the right ballpark."
We have used three methods to estimate the cost of retained earnings, which should
be a single number. To summarize, we found the cost of common equity to be (1) 13.5
percent using the CAPM method; (2) 14.5 percent using the constant growth model, the
DCF approach; and (3) 14.0 percent with the bond-yield-plus-risk-premium approach.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F6cf9dff6-12f1-499a-ae5e-c499eec86ad4%2F37c7db82-70bc-47ec-9db4-dca2a4a4e643%2Ffoxsurg_processed.png&w=3840&q=75)
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