The future earnings, dividends, and common stock price of Carpetto Technologies

Question

The future earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow 4% per year. Carpetto's common stock currently sells for $26.25 per share; its last dividend was $2.00; and it will pay a $2.08 dividend at the end of the current year.

1. Using the DCF approach, what is its cost of common equity? Round your answer to two decimal places.
________ %

2. If the firm's beta is 0.90, the risk-free rate is 7%, and the average return on the market is 12%, what will be the firm's cost of common equity using the CAPM approach? Round your answer to two decimal places.
________ %

3. If the firm's bonds earn a return of 12%, 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.
________ % (the answer is not 17%)

4. 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.
________ % (the answer is not 13.47%)

Explanation / Answer

1. Price = Dividend*(1+g)/(k-g)

26.25=2.08/(k-.04)

Cost of equity(k)=.04+2.08/26.25 =0.119238095= 11.924%

2. Cost of equity = 7% +0.9*(12%-7%) = 11.5%

3. r s =long term bond yield+ risk premium =12%+(12%-7%) =17%

4. Carpetto's cost of common equity =(11.924%+11.5%+17%)/3= 13.47%

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