Barton Industries estimates its cost of common equity by using three approaches:
ID: 2724174 • Letter: B
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 $2.00 and it expects dividends to grow at a constant rate g = 3.6%. The firm's current common stock price, P0, is $23.00. The current risk-free rate, rRF, = 4.9%; the market risk premium, RPM, = 6.2%, and the firm's stock has a current beta, b, = 1. Assume that the firm's cost of debt, rd, is 7.5%. The firm uses a 4.2% 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.
What is your best estimate of the firm's cost of equity?
CAPM cost of equity: % Bond yield plus risk premium: % DCF cost of equity: %Explanation / Answer
CAPM
Ke=.049+1*.062
=11.2%
Bond yield plus risk premium:
Ke =.075+.042
=11.7%
DCF cost of equity:
Ke=(2/23)+.036
=12.29%
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