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 $29.25 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.
Required:
a) Using the discounted cash flow approach, what is its cost of equity?
b) If the firm's beta is 1.3, the risk-free rate is 8%, and the expected return on the market is 13%, then what would be the firm's cost of equity based on the CAPM approach?
c) If the firm's bonds earn a return of 12%, 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?
d) 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. Justify your answer with the appropriate computations.