i. If the firm’s beta is 1.25, the risk-free rate is 6.5 %, and the average return on the market is 13.5%, what will be the firm’s cost of common equity using the CAPM approach? ii. If the firm’s bonds earn a return calculated in part (i), based on the bond-yield-plus-risk- premium approach, what will be cost of common equity? Use the 3.5 % risk premium.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Excelon Company’s earnings per share (EPS) for the last 10 years averages to around $ 6.8.
The common stock, 7.8 million shares outstanding, is now (1/1/21) selling for $68.00 per
share. The expected dividend at the end of the current year (12/31/21) is 55% of the 2019 EPS
which is $7.8. Investors expect past trends to continue, g may be based on the historical
earnings growth rate which is 7.5 percent per year on average.
Excelon has 25-year non-callable bonds outstanding with a face value of $1,000, an 12%
annual coupon, and a market price of $1,300. Excelon can issue perpetual
a price of $45.50 a share. The stock would pay a constant annual dividend of $3.60 a share.
Its capital structure, considered to be optimal, is as follows:
Debt $105,000,000
Preferred Stock $10,000,000
Common equity $145,000,000
Total liabilities and equity $260,000,000
i. If the firm’s beta is 1.25, the risk-free rate is 6.5 %, and the average return on the market is
13.5%, what will be the firm’s
ii. If the firm’s bonds earn a return calculated in part (i), based on the bond-yield-plus-risk-
premium approach, what will be cost of common equity? Use the 3.5 % risk premium.
iii. If you have equal confidence in the inputs used for the three approaches, what is your
estimate of Excelon’s cost of common equity.
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