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Finance 351: Financial Management
Instructor: Shuming Liu
InClass Exercise 9
Solution to Minicase for Chapter 13
Bernice needs to explain to her boss, Mr. Brinestone, that appropriate rates of return for cost of
capital calculations are the rates of return that investors can earn on comparable risk investments in
the capital market.
Mr. Brinestone’s estimate of the cost of equity is his target value for the book
return on equity; it is not the expected rate of return that investors demand on shares of stock with
the same risk as Sea Shore Salt.
Bernice’s CAPM calculation indicates that the correct value for the equity rate is 10.5%.
This value
is broadly consistent with the rate one would infer from the constant growth dividend discount
model (which seems appropriate for a mature firm like this one with stable growth prospects).
The
dividend discount model implies a cost of equity of a bit more than 11 percent:
r
equity
%
7
.
11
117
.
0
067
.
0
40
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This note was uploaded on 11/18/2011 for the course FIN 351 taught by Professor Li during the Fall '09 term at S.F. State.
 Fall '09
 LI
 Finance

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