Luxury Suites has hired you as a consultant to estimate its cost of common equity. After talking with its CFO and an econometric forecasting firm, you have come up with the following facts and estimates:

Estimates:

P₀ = $85

b_{Luxury Suites} = 1.50

Treasury security rate = 10%

Market yield on comparable

quality long-term debt = 13%

Expected return on the market

portfolio = 16%

Expected risk premium of stocks

over bonds = 4%

Current earnings per share, EPS = $5.75

Year Dividends Per Share for previous years

-5 $1.21

-4 $1.21

-3 $1.30

-2 $1.40

-1 $1.71

0 $1.86

Luxury Suites plans to use 30 percent debt and 70 percent equity for its incremental financing. Also, the firms marginal tax rate is 33 percent.

a. What do you estimate the past growth rate in cash dividends per share has been? Employ this as your estimate of g (round to the nearest whole number).

b. What is the estimated cost of common equity employing the following approaches: (1) dividend valuation, (2) CAPM, and (3) bond yield plus expected risk premium?

c. Explain why one of the estimates from (b) is substantially lower than the other two.

d. Take an average of all three answers from (b) for your estimate of Luxurys cost of common equity. d. What is your estimate of Luxurys opportunity cost of capital? How confident of it are you?