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Estimate of luxury opportunity cost of capital

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Luxury Suites has hired you as a consultant to estimate its cost of common equity. After talking with its CFO and an econometric forecasting firm, you have come up with the following facts and estimates:

Estimates
P0 = $85
bLuxury Suites = 1.50
Treasury security rate = 10%
Market yield on comparable
quality long-term debt = 13%
Expected return on the market
portfolio = 16%
Expected risk premium of stocks
over bonds = 4%
Current earnings per share, EPS = $5.75

Year Dividends Per Share for previous years

-5 $1.21
-4 $1.21
-3 $1.30
-2 $1.40
-1 $1.71
0 $1.86

Luxury Suites plans to use 30 percent debt and 70 percent equity for its incremental financing. Also, the firm's marginal tax rate is 33 percent.

-What do you estimate the past growth rate in cash dividends per share has been? Employ this as your estimate of g (round to the nearest whole number)

-What is the estimated cost of common equity employing the following approaches: (1) dividend valuation, (2) CAPM, and (3) bond yield plus expected risk premium?

-Explain why one of the estimates from (b) is substantially lower than the other two.

-What is your estimate of Luxury's opportunity cost of capital? How confident of it are you?

Reference no: EM133070772

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