Answer:
Kennedy's cost of internal equity using the bond-yield-plus-risk-premium approach is estimated to be 15.07%.
Explanation:
The bond-yield-plus-risk-premium approach is one of the methods used to estimate the cost of internal equity, which assumes that the cost of equity is equal to the sum of the risk-free rate and a risk premium based on the company's perceived risk relative to that of the market.
Using this approach, Kennedy's cost of internal equity can be estimated as follows:
Cost of internal equity = Risk-free rate + Equity risk premium
Given that Kennedy's bonds yield 11.52%, we can assume that the risk-free rate is 11.52%.
The firm's analysts estimate that the firm's risk premium on its stock over its bonds is 3.55%. Therefore, the equity risk premium for Kennedy can be calculated as follows:
Equity risk premium = Risk premium on stock - Risk premium on bonds
Equity risk premium = 3.55% - 0% (since Kennedy is a closely held company and does not have publicly traded bonds)
So, the equity risk premium for Kennedy is 3.55%.
Therefore, the cost of internal equity for Kennedy using the bond-yield-plus-risk-premium approach can be calculated as:
Cost of internal equity = Risk-free rate + Equity risk premium
Cost of internal equity = 11.52% + 3.55%
Cost of internal equity = 15.07%
So, Kennedy's cost of internal equity using the bond-yield-plus-risk-premium approach is estimated to be 15.07%.