# CAPM approach

The case is about cost of capital. I do not have idea how to solve it, which formulas to use... I do not understand anything. I do not know where which formulas to use. Could you explain in each question which formulas should I use. I don't ask for doing this assignment for me, I just need some help and some more explanation to solve them. If you can not solve all the questions, solve as much as you can. Even 1-2 questions make a big sense. This course is very important for me and case studies are 40% of overall degree, so please help me.

Thanks in advance.

https://brainmass.com/business/discounted-cash-flows-model/case-study-corporate-finance-class-226364

#### Solution Preview

(1) Yes, it does seem appropriate because the unlevered beta, or asset beta and the operating leverage are linked since this beta is determined by both the business in which the company operates and the operating leverage of that company. Operating leverage relates change in activity (measured by sales) with change in result (either operating profit or net income). Higher operating leverage will lead to greater risk for the ...

#### Solution Summary

CAPM approach is applied.

Shelby Inc: Analyzing Projects': NPV, IRR, MIRR, PI & Cost of Equity Using the CAPM Approach

1. Project S has a cost of $10000 and is expected to produce benefits (cash flows) of $3000 per year for 5 years. Project L cost $25,000 and is expected to produce cash flows of $7400 per year for 5 years. Calculate the two projects' NPVs, IRRs, MIRRs, and PIs, assuming they are mutually exclusive, using each ranking methods? Which should actually be selected?

2. The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby's common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year.

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

b. If the firm's beta is 1.6 , the risk free rate is 9%, and the expected return on the market is 13%, what will be the firm's cost of equity using CAPM approach?

c. If the firm's bonds earn a return of 12%, what will Rs be using bond-yield-plus-risk-premium approach?

d. On the basis of the results of parts a through c, what would you estimate Shelby's cost of equity to be?

3. Thress industries just paid a dividend of $1.50 a share (i.e., D0=$1.50). The dividend is expected to grow 5% a year for the next 3 years, and then 10% a year thereafter. What is the expected dividend per share for each of the next 5 years?

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