2. Compute the cost of common equity using the CAPM model. For beta, use the ave
ID: 2670437 • Letter: 2
Question
2. Compute the cost of common equity using the CAPM model. For beta, use the average beta of three selected competitors. You may obtain the betas from Yahoo Finance. Assume the risk free rate to be 3% and the market risk premium to be 4%.a. What is the cost of common equity? (5 pts)
Risk free Rate 3%
Market risk premium, MRP 4%
Competitors Beta As on October 4, 2011
Dendreon Corp .65 http://finance.yahoo.com/q/ks?s=RTN+Key+Statistics
Douglas Emmet 1.40 http://finance.yahoo.com/q/ks?s=BA+Key+Statistics
Raytheon Company Common Stock 1.07 http://finance.yahoo.com/q/ks?s=LMT+Key+Statistics
Average Beta 1.04
b. Explain the advantages and disadvantages to use the CAPM model as the method to compute the cost of common equity. Compare and contrast this method with the dividend growth model approach. (10 pts)
3. Compute the cost of preferred equity assuming the dividend paid for preferred stock is $2.93 and the current value of the stock is $50 per share.
a. What is the cost of preferred equity? (5 pts)
b. Is there any other method to compute this cost? Explain. (5 pts)
4. Assuming that the market value weights of these capital sources are 30% bonds, 60% common equity and 10% preferred equity, what is the weighted cost of capital of the firm? (10 pts)
5. Should the firm use this WACC for all projects? Explain and provide examples as appropriate. (10 pts)
6. Recompute the net present value of the project based on the cost of capital you found. Do you still believe that your earlier recommendation for accepting or rejecting the project was adequate? Why or why not? (5 pts)
Explanation / Answer
You should find a lot of assistance here, since spreadsheets used to demo these calcs: http://pages.stern.nyu.edu/~adamodar/ Use the search at this site such as Weighted Cost of Capital http://search.freefind.com/find.html?id=… Click on spreadsheets: Look down at the spreadsheet list lower on the page, one calculates ratings Very good illustrations of valuation and methods
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