Cost of Common Equity The future earnings, dividends, and common stock price of
ID: 2785445 • Letter: C
Question
Cost of Common Equity
The future earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow 3% per year. Carpetto's common stock currently sells for $26.00 per share; its last dividend was $2.00; and it will pay a $2.06 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 1.20, the risk-free rate is 3%, 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.Using DCF approach,
Rs = D1/P0 + g = 2.06/26 + 0.03 = 0.1092 = 10.92%
b. Using CAPM,
Rs = Rf + Beta*(Rm - Rf) = 3% + 1.2*(14%-3%) = 16.2%
c. The suggested risk premium is between 3% and 5%. Therefore,
Rs = 10% + (3%+5%)/2 = 14%
d. Cost of Equity = (10.92% + 16.2% + 14%)/3 = 13.71%