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solution

The future earnings, dividends, and common stock price of Callahan Technologies Inc. are expected to grow at 6% per year in the future. Callahan’s common stock currently sells for $22.00 per share; its last dividend was $2.00; and it will pay a $2.12 dividend at the end of this year.

a.Using the discounted cash flow (DCF) approach, what is its cost of equity?

b.If the firm’s beta is 1.2, the risk-free rate is 6%, and the expected return on the market is 13%, what will be the firm’s cost of common equity using the CAPM approach?

c.If the firm’s bonds earn a return of 11%, then what would be your estimate of rs using the own-bond-yield-plus-judgmental-risk-premium approach? (Hint: use the mid-point of the risk premium range discussed in Section 9-10b)

d.On the basis of the result of Parts a through c, what would be your estimate of Callahan’s cost of equity if you have equal confidence in the inputs?

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