Quantitative Problem: Barton 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 $1.80 and it expects dividends to grow at a constant rate g = 5.9%. The firm's current common stock price, P0, is $30.00. The current risk-free rate, rRF, = 5%; the market risk premium, RPM, = 6.3%, and the firm's stock has a current beta, b, = 1.1. Assume that the firm's cost of debt, rd, is 7.62%. 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.
CAPM cost of equity: | % |
Bond yield plus risk premium: | % |
DCF cost of equity: | % |
What is your best estimate of the firm's cost of equity?
1-The best estimate is the highest percentage of the three
approaches.
2-The best estimate is the average of the three approaches.
3-The best estimate is the lowest percentage of the three approaches.
CAPM cost of equity:
As per CAPM |
expected return = risk-free rate + beta * (Market risk premium) |
Expected return% = 5 + 1.1 * (6.3) |
Expected return% = 11.93 |
Bond yield plus risk premium:
Cost of equity = bond rate+equity premium = 7.62+4.3=11.92%
DCF cost of equity:
As per DDM |
Price = Dividend in 1 year/(cost of equity - growth rate) |
30 = 1.8/ (Cost of equity - 0.059) |
Cost of equity% = 11.9 |
Best estimate is
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