5. The cost of retained earnings The cost of retained earnings If a firm cannot invest retained earnings to earn a rate of return. the required rate of return on retained earnings, it should return those funds to its stockholders. The cost of equity using the CAPM approach The yleld on a three-month T-bill is 2%, the yleld on a 10 -year T-bond is 3.24%. The market risk premium is 6.16% and the Wilson Company has a beta of 0.85. Using the Capital Asset Pricing Model (CAPM) approach, Wison's cost of equity is The cost of equity using the bond yield plus risk premium approach In contrast, the Harrison Company is closely held and, therefore, cannot generate reliable inputs with which to apply the CAPM method to estimate its cost of internal equity (retained earnings). Howeven its management knows that its outstanding bonds are currently ylelding 7.45%, and the firm's analysts estimate that the risk premium of its stocks over its bonds is currently 1,57%. As result, Harrison's cost of internal equity ( ( i. )-based on the own-bond-yield-plus-judgernental-risk-premium approach-is: 10.82% 11.27% The cost of equity using the discounted cash flow (or dividend-yleld-plus-growth-rate) approach Ford Enterprises's stock is currently selling for $22.25 per share, and the firm expects its per-share dividend to.be $2.50 in one year. Analysts project the firm's growth rate to be constant at 3.00%. Using'the discounted cash flow (or dividend-yield-plus-growth-rate) approach, what is Ford's cost of internal equity? 14.24%19.22%13.53%12.10% 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 dividendYield-plus-growth-rate) approach. In general, there are three avallable 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. the firms growtn cate to be constant at 3.00%, Using the discounted casn fiow (or dwidend-yeid-plus-growtn-rate) approach, wnat is rords cost of internal equity? 14.24%19.22%13.53%12.10% 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 dividendyield-plus-growth-rate) approach. In general, there are three avallable methods to generate such an estimate: suppose roro tnterpnsess is currently distributing 55% of its earning as equity (ROE) of 15,50%. It is reasonable to estimate Ford's growth rate is
