Problem:

The earnings, dividends, and common stock price of Shelby Inc. are expected to grow at 3% per year in the future. Shelby's common stock sells for $23.25 per share, its last dividend was $2.00, and the company will pay a dividend of $2.06 at the end of the current year.

Task:

Question 1: Using the discounted cash flow approach, what is its cost of equity?

Question 2: If the firm's beta is 0.9, the risk-free rate is 3%, and the expected return on the market is 14%, then what would be the firm's cost of equity based on the CAPM approach?

Question 3: If the firm's bonds earn a return of 10%, and analysts estimate the market risk premium is 3 to 5 percent, then what would be your estimate of rs using the over-own-bond-yield-plus-judgmental-risk-premium approach?

Question 4: On the basis of the results of parts a through c, what would be your estimate of Shelby's cost of equity? Assume Shelby values each approach equally.

Note: Please describe comprehensively and provide step by step solution.