# fm10 16 - Answer: yes, you could use the DCF using...

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e. 1. What is the estimated cost of equity using the discounted cash flow (DCF) approach? Answer: = s r 0 1 P D = g P ) g 1 ( D 0 0 + + = 05 . 0 50 \$ ) 05 . 1 ( 19 . 4 \$ + = 13.8%. e. 2. Suppose the firm has historically earned 15 percent on equity (ROE) and retained 35 percent of earnings, and investors expect this situation to continue in the future. How could you use this information to estimate the future dividend growth rate, and what growth rate would you get? Is this consistent with the 5 percent growth rate given earlier? Answer: Another method for estimating the growth rate is to use the retention growth model: g = (1 - Payout Ratio)ROE In this case g = (0.35)0.15 = 5.25%. This is consistent with the 5% rate given earlier. e. 3. Could the DCF method be applied if the growth rate was not constant? How?
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Unformatted text preview: Answer: yes, you could use the DCF using nonconstant growth. You would find the PV of the dividends during the nonconstant growth period and add this value to the PV of the series of inflows when growth is assumed to become constant. f. What is the cost of equity based on the bond-yield-plus-risk-premium method? Answer: r s = companys own bond yield + risk premium. First find the YTM of the bond: Enter n = 30, PV = -1153.72, pmt = 60, and FV = 1000, and then press the i button to find r/2 = i = 5%. Since this is a semiannual rate, multiply by 2 to find the annual rate, r = 10%. The assumed risk premium is 4%, thus r s = 0.10 + 0.04 = 14%. Mini Case: 10 - 16...
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## This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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