Related to Checkpoint 14.2 and Checkpoint 14.3) (Cost of common equity)The commo
ID: 2741449 • Letter: R
Question
Related to Checkpoint 14.2 and Checkpoint 14.3) (Cost of common equity)The common stock for the Hetterbrand Corporation sells for $59.6659.66, and the last dividend paid was $2.272.27. Five years ago the firm paid $1.851.85 per share, and dividends are expected to grow at the same annual rate in the future as they did over the past five years. a. What is the estimated cost of common equity to the firm using the dividend growth model? b. Hetterbrand's CFO has asked his financial analyst to estimate the firm's cost of common equity using the CAPM as a way of validating the earlier calculations. The risk-free rate of interest is currently 4.54.5 percent, the market risk premium is estimated to be 4.94.9 percent, and Hetterbrand's beta is 0.840.84. What is your estimate of the firm's cost of common equity using this method?
Explanation / Answer
1) Calculation of cost of equity using dividend discount model :
Annual growth rate in dividends = 4.54% (approx = (2.27 - 1.85) / 1.85 = 0.2270/5years = 4.54%)
Given D0 = $2.27
D1= $2.373
Price P0 = $59.66
Using dividend growth model,
Cost of equity = (D1/P0) + g
= (2.373 / 59.66) + 0.0454
= 8.52%
2) Calculation of cost of equity using CAPM Approach :
Using CAPM Approach,
Cost of equity = Risk free rate + Beta * Market risk premium
= 4.5% + 0.84*4.9
= 8.62%