The future earnings , dividends, and common stoc price of Carpetto Tech Inc. are

Question

The future earnings , dividends, and common stoc price of Carpetto Tech Inc. are expected to grow 7% per year. Carpetto's common stock currently sells for $23.00 per share. its last dividend was $2.00 ; and it will pay a $2.14 dividend at the end of the current year.

1. Using a DCF approach, what is its cost of common equity?

2. If the firm's beta is 1.6, the risk free rate is 9%, and the average return on the market is 13%, what will be the firms cost of common equity using the CAPM approach?

3. If the firms bonds earn a return of 12%, based on the bond yield plus risk premium approach, what will be Rs ?

4. If you have equal confidence in the inputs used for the 3 approaches , what is your estimate of Carpetto's cost of common equity?

Please show step by step ( I have a HP10bll+ calculator) so wha ever is easier..)

Explanation / Answer

1.Cost of common equity Ke = D1/P0 +g
D1 = 2.00 (1 + 0.07) = 2.14
Ke = 2.14/23 + 0.07
= 16.30%

2.Required rate of return = Risk free rate + beta x Market risk premium
= 9% + 1.6 (13% - 9%)
=15.4%

3.Rs= Bond yield + Risk premium
=12%+4%
=16%

4.It is difficult to estimate beta and also growth rate has to be assumed to be constant. Thus bond-yield plus risk premium approach is appropriate to calculate cost of equity.
Cost of common equity Ke = D1/P0 +g
=(2.14)/23+7%
=16.3%

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