Score. 0 6f 4 pts 6 of 8 (3 complete) HW Score: 30%, 9 of P14-17 (similar to) i

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Score. 0 6f 4 pts 6 of 8 (3 complete) HW Score: 30%, 9 of P14-17 (similar to) i Question Help I * Related to Checkpoint 14.2 and Checkpoint 14.3) (Cost of common equity) The common stock for the Hetterbrand Corporation sells for $59.76, and the last dividend paid was $2.32. Five years ago the firm paid $1.96 per share, and dividends are expected to grow at the same annual rate in the future as they did over the past five years 3 0 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 4.5 percent, the market risk premium is estimated to be 4.6 percent, and Hetterbrand's beta is 0.77. What is your estimate of the firm's cost of common equity using this method? 1%. (Round a. The estimated cost of common equity to the firm using the dividend growth modelis to two decimal places) ans box and then cic

Explanation / Answer

Answer:

Given:

Current price of stock = $59.76

Dividend last paid = $2.32

Dividend paid 5 years ago = $1.96

Hence dividend growth rate over last 5 years

= (Dividend last paid / Dividend paid 5 year ago) 1/ No of years- 1

= ($2.32 / $1.96)(1/5) - 1

=3.43%

As the dividend are expected to grow at the same rate, future dividend growth rate =3.43%

Answer a:

Cost of equity as per dividend growth model:

Re = (D1 / P0) + g

Where:

Re = Cost of Equity

D1 = Dividends/share next year

P0 = Current stock price

g = Dividend growth rate

Dividends/share next year = D1= $2.32 * $2.32 * 3.43% = $2.3996

Hence,

Cost of Equity = ($2.3996 / $59.76) + 3.43% = 7.45%

The estimated cost of common equity using the dividend growth model is 7.45%

Answer b:

Estimated cost of equity using CAPM:

Re = rf + (rm – rf) * ?

Where:

Re = the required rate of return on equity / cost of equity

Given:

rf = 4.5%

(rm – rf ) = 4.6%

? = 0.77

Hence,

Estimated Cost of equity using CAPM = 4.5% + 4.6% * 0.77 = 8.04%

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