Barton Industries estimates its cost of common equity by using three approaches:

Question

Barton Industries estimates its cost of common equity by using three approaches: the CAPM, the bond-yield-plus-risk-premium approach, and the DCF model. Barton expects next year's annual dividend, D1, to be $1.70 and it expects dividends to grow at a constant rate g = 4.5%. The firm's current common stock price, P0, is $29.00. The current risk-free rate, rRF, = 4.5%; the market risk premium, RPM, = 5.8%, and the firm's stock has a current beta, b, = 1.1. Assume that the firm's cost of debt, rd, is 6.82%. The firm uses a 3.8% risk premium when arriving at a ballpark estimate of its cost of equity using the bond-yield-plus-risk-premium approach. What is the firm's cost of equity using each of these three approaches? Round your answers to 2 decimal places.

Explanation / Answer

1.CAPM Rf + beta× Rm = 4.5% + 1.1×5.8% = 10.88%

2.As per DCF cost of equity is D1/price + growth rate = 1.7/29 + 4.5% = 10.36%

3.Using bondyield pkus risk premium approch= bond yield + risk premium = 6.82% +3.8% = 10.62%

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