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 = 5.2%. The firm's current common stock price, P0, is $21.00. 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, = 1.1. Assume that the firm's cost of debt, rd, is 8.31%. 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.

Explanation / Answer

CAPM :Cost of equity = Rf + [B*RP]

                               = 4.9 + [1.1 * 6.2 ]

                              = 4.9 + 6.82

                               = 11.72%

Bond Yield Risk premium approach = 8.31 + 4.2 = 12.51%

DCF :cost of equity :   [D1 / P0 ] + g

                              = [1.7/21] + .052

                             = .0810 +.052

                                = 13.30%

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