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. False O True The cost of equity using the CAPM approach The current risk-free rate of return (TRF) is 3.86% while the market risk premium is 6.63%. The Monroe Company has a beta of 0.92. Using the capital asset pricing model (CAPM) approach, Monroe's cost of equity is The cost of equity using the bond yield plus risk premium approach The Lincoln 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. Lincoln's bonds yield 11.52%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4.95%. Based on the bond-yield-plus-risk-premium approach, Lincoln's cost of internal equity is: 19.76% 16.47% 15.65% O 18.12%
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.
![**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.
- [ ] False
- [ ] True
**The Cost of Equity Using the CAPM Approach**
The current risk-free rate of return (\(r_{RF}\)) is 3.86% while the market risk premium is 6.63%. The Monroe Company has a beta of 0.92. Using the capital asset pricing model (CAPM) approach, Monroe’s cost of equity is ______.
**The Cost of Equity Using the Bond Yield Plus Risk Premium Approach**
The Lincoln 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. Lincoln’s bonds yield 11.52%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 4.95%. Based on the bond-yield-plus-risk-premium approach, Lincoln’s cost of internal equity is:
- [ ] 19.76%
- [ ] 16.47%
- [ ] 15.65%
- [ ] 18.12%](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Ff8a86740-781a-4204-bc63-549b5147664d%2Fdfdd1e9b-4424-4b8e-834a-cb8cb5ac91ad%2Fqprdkl_processed.jpeg&w=3840&q=75)
The company can measure the cost that will be incurred by the company if it raises funds using equity financing. In other words, for procuring funds from the public by issuing stocks the cost is incurred which will be referred to as equity cost.
There are various methods for determining the equity cost such as CAPM model, DDM approach, etc.
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