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 $20.75 per share; its last dividend was $1.80; and it will pay a $1.89 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 1.50, the risk-free rate is 5%, and the average return on the market is 14%, 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 8%, 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

a. According to DCF, the Cost of equity = Ke = D1/P0 + g

D1 = 1.89

P0 = 20.75

g = 0.05

Cost of equity = Ke = 1.89/20.75 + 0.05 = 0.1411 = 14.11%

b. According to CAPM. Cost of equity = Rf + beta*(Rm -Rf)

Cost of equity = 5 + 1.5*(14-5) = 18.5%

c. Using yield-plus-risk premium approach, Rs = Bond yield + risk premium

Rs = 8 + (14-5) = 8 + 9 = 17%

d. Assuming equal confidence, the cost of equity = 1/3*14.11 + 1/3* 18.5 + 1/3*17 = 16.54%

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