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 $27.75 per share; its last dividend was $2.40; and it will pay a $2.52 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 1.10, 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. (WACC is 10.47%) 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

Part 1)

The cost of common equity with the use of DCF approach is calculated as follows:

Cost of Common Equity = D1/Current Stock Price + Growth Rate

________

Here, D1 = $2.52, Current Stock Price = $27.75 and Growth Rate = 5%

Using these values in the above formula, we get,

Cost of Common Equity = 2.52/27.75 + 5% = 14.08%

________

Part 2)

The cost of common equity with the use of CAPM approach is calculated as follows:

Cost of Common Equity = Risk Free Rate + Beta*(Market Return - Risk Free Rate)

________

Here, Risk Free Rate = 4%, Beta = 1.10 and Market Return = 12%

Using these values in the above formula, we get,

Cost of Common Equity = 4% + 1.10*(12% - 4%) = 12.80%

________

Part 3)

The value of rs with the use of bond-yield-plus-risk-premium approach is calculated as follows:

rs = Bond Rate + Risk Premium = 10% + 4% = 14%

________

Part 4)

With equal confidence in all the 3 approaches, we will have to take the average of the cost of common equity under all the 3 methods.

Cost of Common Equity (Equal Confidence) = (14.08 + 12.80 + 14)/3 = 13.63%

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