Question

A. Butcher Timber Company hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 10.50%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?

Answer 1

14.35%

Step-by-step explanation:

In this given case, Risk free return will be yield on bond = 10.50%

Risk Premium given = 3.85%

But beta of company is not given, and market beta also not given, hence we can not calculate beta.

we can assume beta of company is 1, then-

Cost of equity can be calculated as:

= Risk free return + [Beta × Risk Premium]

= 10.50% + [1 × 3.85%]

= 10.50% + 3.85%

= 14.35%

Note:

Retained earning also not given so that we calculate based of retained earning.