The earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow at 7 percent per year in the future. Carpetto's common stock sells for $23 per share, its last dividend was $2.00, and it will pay a dividend of $2.14 at the end of the current year. THIS IS A FOUR PART QUESTION, NOT MULTIPLE CHOICE.
(a) Using the DCF approach, what is the cost of common equity?
(b) If the firm's beta is 1.6, the risk-free rate is 9 percent, and the average return on the market is 13 percent, what will be the firm's cost of common equity using the CAPM approach?
(c) If the firm's bonds earn a return of 12 percent, what will rs be based on the bond-yield-plus-risk-premium approach, using the midpoint of the risk premium range?
(d) Assuming you have equal confidence in the inputs used for the three approaches, what is your estimate of Carpetto's cost of common equity? (FILL IN THE BLANK)
SOLUTION
PREVIEW
(a) Using the DCF approach, what is the cost of
common equity? (FILL IN THE BLANK)
Cost of common equity Ke =
D1/P0 +g
D1 = 2.00 (1 + 0.07) = 2.14
