Question

The Harrison Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Harrison’s bonds yield 11.52%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Harrison’s cost of internal equity is:a. 15.23% b. 16.75% c. 19.04% d. 18.28%

Answer 1

Answer:

the formula used to calculate the cost of equity (required rate of return) based on the bond yield plus risk premium is fairly simple:

cost of equity (Re) = yield of debt (bonds) + firm's risk premium = 11.52% + 3.55% = 15.07%

I'm not sure if the question was copied correctly or not, so I looked for similar questions and it included different numbers.

The Harrison Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company's cost of internal equity. Harrison's bonds yield 10.28%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4.95%. Based on the bond-yield-plus-risk-premium approach, Harrison's cost of Internal equity is: = 10.28% + 4.95% = 15.23%

Another question:

The Kennedy Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company's cost of internal equity. Kennedy's bonds yield 11.52%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4.95%. Based on the bond-yield-plus-risk-premium approach, Kennedy's cost of internal equity is: = 11.52% + 4.95% = 16.47%