The earnings, dividends, and stock price of Shelby Inc. arc expected to grow at 7% per year in the future. Shelby’s common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year.

- Using the discounted cash flow approach, what is its cost of equity?

- If the firm’s beta is 1.6, the risk-free rate is 9%, and the expected return on the market

is 13%, then what would be the firm’s cost of equity), based on the CAPM approach?

- If the firm’s bonds earn a return of 12%, then what would be your estimate of return on stock using the over-own-bond-yield-plus-judgmental-risk-premium approach? (
*Hint:*Use the midpoint of the risk premium range of 4%) - On the basis of the results of parts a through c, what would be your estimate of

Shelby’s cost of equity?

12-1

Broussard Skateboard’s sales are expected to increase by 15% from $8 million in

2013 to $9.2 million in 2014. Its assets totaled $5 million at the end of 2013.

Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2013, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 6%, and the forecasted payout ratio is 40%. Use the AFN equation to forecast Broussard’s additional funds needed for the coming year.

15-3

Ethier Enterprise has an unlevered beta of 1.0. Ethier is financed with 50% debt and has a levered beta of 1.6. If the risk-free rate is 5.5% and the market risk premium is 6%, how much is the additional premium that Ethier’s shareholders require to be compensated for financial risk?

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