The current market price of a firm's bonds is $970 per $1,000 par value. The bonds have 5 years to maturity, a 10% coupon, and the firms marginal tax rate is 40%. The firm also has preferred stock with a par value of $100 per share, currently priced at $20 per share with an annual dividend of $3 per share. The risk-free rate is presently 5% and the market return is 12%. The firm's next common stock dividend is expected to be $2.10, with a projected growth rate of 5.75%. Its common stock currently sells for $20 per share with a beta of 1.5. Finally, the firms target capital structure is 10% preferred, 40% debt and 50% equity.

.Use the discounted cash flow approach (also known as the constant growth or Gordon model) to compute the cost of equity.

a) 15.50%

b) 16.25%

c) 16.85%

d) 17.48%

e) 19.22%

The current market price of a firm's bonds is $970 per $1,000 par value. The bonds have 5 years to maturity, a 10% coupon, and the firms marginal tax rate is 40%. The firm also has preferred stock with a par value of $100 per share, currently priced at $20 per share with an annual dividend of $3 per share. The risk-free rate is presently 5% and the market risk premium is 7%. The firm's next common stock dividend is expected to be $2.10, with a projected growth rate of 5.75%. Its common stock currently sells for $20 per share with a beta of 1.5. Finally, the firms target capital structure is 10% preferred, 40% debt and 50% equity.

.Use the CAPM approach to estimate the cost of equity:

a) 7.0%

b) 12.5%

c) 14.5%

d) 15.5%

e) 16.85%