Omega Inc. has a history of abnormally high growth due to general economic fluctuations. Estimating the cost of common equity using the discounted cash flow approach is difficult because:
A) the dividend yield is extremely difficult to estimate.
B) the proper growth rate is difficult to establish.
C) the market price of the common equity is very volatile.
D) the firm grows at a constant rate in perpetuity.
E) the firm's historical data of dividend yield is unavailable.

Question

Quizplus · Accepted Answer

The difficulty in estimating the cost of common equity using the discounted cash flow approach is mainly due to the challenge in establishing the proper growth rate. This is particularly true for a company like Omega Inc., which has a history of abnormally high growth due to general economic fluctuations. Since the discounted cash flow approach relies heavily on assumptions about future growth rates, any uncertainty in estimating this rate can lead to significant errors in the final cost of equity estimate.

Omega Inc Has a History of Abnormally High Growth Due to to General