The common stock for the hetterbrand corporation sells for $60.33 and the last d

Question

The common stock for the hetterbrand corporation sells for $60.33 and the last dividend paid was $2.18.Five years ago the firm paid $1.89 per share and dividends are expected to grow at the same annual rate in future as they did over the past five years.

A. what is the estimated cost of common equity to the firm using the dividend growth model?

b. Hetterbrand’s CFO has asked his financial analyst to estimate the firm’s equity using the CAPM as way of validating the earlier calculations. The risk free rate of interest is currently 4.5 percent, the market risk premium is estimated to be 52 percent and Hetterbrands’s beta is 0.72. What is the estimate of the firm’s cost of common equity using this model?

Explanation / Answer

Solution:

A. Cost of Common Equity using dividend growth model = Next Year Expected Dividend (D1) / Current Market Price (P0) + Growth Rate (G)

Growth Rate = (($2.18 - $1.89) / 1.89) / 5 x 100 = 3.0688% annual growth rate or 3.07%

Next Year Expected Dividend (D1) = Last Dividned Paid (D0) x (1 + Growth Rate) = $2.18 x (1 + 0.0307) = $2.247

Current Stock PRice = $60.33

Cost of Common Equity = $2.247 / $60.33 + 0.0307

= 0.037245 + 0.0307

= 0.067945 or 6.80%

B) Cost of Common Equity using CAPM = Risk Free Return + Beta x Market Risk Premium

= 4.5% + 0.72 x 52%

= 4.5% + 37.44%

= 41.94%

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