Cost of Common Equity The future earnings, dividends, and common stock price of
ID: 2777443 • Letter: C
Question
Cost of Common Equity
The future earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow 8% per year. Carpetto's common stock currently sells for $28.00 per share; its last dividend was $2.50; and it will pay a $2.70 dividend at the end of the current year.
Using the DCF approach, what is its cost of common equity? Round your answer to two decimal places.
%
If the firm's beta is 1.00, the risk-free rate is 8%, and the average return on the market is 14%, what will be the firm's cost of common equity using the CAPM approach? Round your answer to two decimal places.
%
If the firm's bonds earn a return of 10%, based on the bond-yield-plus-risk-premium approach, what will be rs? Use the midpoint of the risk premium range discussed in Section 10-5 in your calculations. Round your answer to two decimal places.
%
If you have equal confidence in the inputs used for the three approaches, what is your estimate of Carpetto's cost of common equity? Round your answer to two decimal places.
Explanation / Answer
a) As per Question below are given,
Growth Rate (r) = 8%
Last Dividend Paid (D0) = $2.50
Current Dividend (D1) = $2.70
Price of Stock = $28.00
Now, As per DCF,
Cost of equity = ( Dividend1 / Price of stock ) + Growth rate
= ( 2.70 / 28) + 8
= 8.1 %
b) Risk free rate = 8%, expected market return rate = 14 %
As per CAPM,
Rate = Risk free rate + Beta x( expected market return – risk free rate)
Rate = 8 + 1 x (14 – 8)
Rate = 14%
c)
Risk premium = Dividend yield + earning growth – long term bond yield
= 8 + 8 – 10 = 6%
As per bond-yield-plus-risk-premium approach,
Cost of equity = Long term bond yield + Risk premium
= 10 + 6 = 16 %
(If risk premium is already given in section 10-5, use that one)