Question

Cost of Common Equity The future earnings, dividends, and common stock price of Carpetto Technologies Inc....

Cost of Common Equity

The future earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow 4% per year. Carpetto's common stock currently sells for $25.50 per share; its last dividend was $2.00; and it will pay a $2.08 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.
    %

  2. 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.
    %

  3. If the firm's bonds earn a return of 9%, 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.
    %

  4. 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.

Homework Answers

Answer #1

Answer a.

Cost of Common Equity = Expected Dividend / Current Price + Growth Rate
Cost of Common Equity = $2.08 / $25.50 + 0.04
Cost of Common Equity = 0.0816 + 0.0400
Cost of Common Equity = 0.1216 or 12.16%

Answer b.

Cost of Common Equity = Risk-free Rate + Beta * (Return on Market - Risk-free Rate)
Cost of Common Equity = 3.00% + 1.30 * (12.00% - 3.00%)
Cost of Common Equity = 3.00% + 1.30 * 9.00%
Cost of Common Equity = 14.70%

Answer c.

Risk premium range is 3.00% to 5.00%. Midpoint of risk premium range is 4.00%

Cost of Common Equity = Bond Yield + Risk Premium
Cost of Common Equity = 9.00% + 4.00%
Cost of Common Equity = 13.00%

Answer d.

Estimated Cost of Common Equity = Average of Cost of Common Equity under 3 different methods
Estimated Cost of Common Equity = (12.16% + 14.70% + 13.00%) / 3
Estimated Cost of Common Equity = 39.86% / 3
Estimated Cost of Common Equity = 13.29%

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