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:

A. 19.76%

B. 16.47%

C. 18.12%

D. 15.65%

Answer 1

Answer:

Option (B) is correct.

Explanation:

Here, we are using the CAPM method for estimating a company's cost of internal equity.

Given that,

Kennedy's bonds yield = 11.52 percent

Firm's risk premium on its stock over its bonds = 4.95%

Based on the bond-yield-plus-risk-premium approach, Kennedy's cost of internal equity is as follows:

Kennedy's cost of internal equity:

= Kennedy's bonds yield + Firm's risk premium on its stock over its bonds

= 11.52% + 4.95%

= 16.47%