arton Industries estimates its cost of common equity by using three approaches:
ID: 2727372 • Letter: A
Question
arton 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 $2.20 and it expects dividends to grow at a constant rate g = 5.5%. The firm's current common stock price, P0, is $26.00. The current risk-free rate, rRF, = 5%; the market risk premium, RPM, = 6.3%, and the firm's stock has a current beta, b, = 1.3. Assume that the firm's cost of debt, rd, is 9.28%. The firm uses a 4.3% 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.
QUESTIONS TO ANSWER:
CAPM cost of equity: % Bond yield plus risk premium: % DCF cost of equity: %Explanation / Answer
CAPM
Cost of equity = Rf + RPM x beta
= 5%+ 6.30% x1.30
= 13.19%
Bond yield plus risk premium
Cost of equity = bond yield + risk premium
= 9.28% +4.30%
= 13.58%
DCF cost of equity
Cost of Equity = D1/Po + g
= 2.20 / 26 + 0.055
= 13.96%
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