Question

The future earnings, dividends, and common stock price of Callahan Technologies Inc. are expected to grow 6% per year. Callahan's common stock currently sells for $25.75 per share; its last dividend was $2.00; and it will pay a $2.12 dividend at the end of the current year.

1. Using the DCF approach, what is its cost of common equity? Round your answer to two decimal places. Do not round your intermediate calculations.
   %
2. 
   
3. If the firm's beta is 1.30, the risk-free rate is 3%, 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.
   %
4. 
   
5. If the firm's bonds earn a return of 12%, based on the bond-yield-plus-risk-premium approach, what will be r_s? Use the midpoint of the risk premium range discussed in Section 10-5 in your calculations. Round your answer to two decimal places.
   %
6. 
   
7. If you have equal confidence in the inputs used for the three approaches, what is your estimate of Callahan's cost of common equity? Round your answer to two decimal places. Do not round your intermediate calculations. %

Answer 1

a. Cost of equity using DCF model=(D1/Share price)+growth rate

=(2.12/25.75)+6%

=8.23%+6%

=14.23%

b. Cost of equity using CAPM model=risk free rate+(beta*(market return-risk free rate))=3%+(1.3*(12%-3%))=14.7%

c. Risk premium is not given. I am assuming 3%. If you have anything please use that.

Cost of equity=bond yield+risk premium=12%+3%=15%

d. If having equal confidence, then take average to find the cost of equity

Cost of equity=(14.23%+14.7%+15%)/3=14.64%