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 5% per year. Carpetto's common stock currently sells for $23.75 per share; its last dividend was $1.60; and it will pay a $1.68 dividend at the end of the current year.

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

If the firm's beta is 2.10, the risk-free rate is 4%, 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.
%

If the firm's bonds earn a return of 10%, 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.
%

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.
%

Explanation / Answer

Answer a.

Cost of Equity = D1 / P0 + g

Cost of Equity = 1.68/23.75 + 0.05

Cost of Equity = 0.1207 = 12.07%

Answer b.

rs = rRF + (rM - rRF)b

rs = 0.04 + (0.12 – 0.04)*2.10

rs = 0.2080 = 20.80%

Answer c.

Risk premium is in the range of 3% to 5%. So, average of the range is 4%.

rs = Bond rate + Risk premium

rs = 10% + 4% = 14%

Answer d.

Equal confidence implies equal weighting being given to each of the estimates, and an overall estimate of the firm’s cost of common equity can be calculated as an average across the estimates:

Rs = (12.07% + 20.80% + 14%)/3 = 15.62%

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