Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 30%, and the current dividend yield is 2%. Its beta is 1.2, the market risk premium is 8%, and the risk-free rate is 4%.
a. Use the CAPM to estimate the firm’s cost of equity.
b. Now use the constant growth model to estimate the cost of equity. c. Which of the two estimates is more reasonable?