(Cost of common equity) The common stock for the Hetterbrand Corporation sells f

Question

(Cost of common equity) The common stock for the Hetterbrand Corporation sells for $59.17, and the last dividend paid was $2.24. Five years ago the firm paid $1.84 per share, and dividends are expected to grow at the same annual rate in the figure as they did over the past five years.

What is the estimated cost of common equity to the firm using the dividend growth model? (Round to two decimal places.)

Hetterbrand's CFO has asked his financial analyst to estimate the firm's cost of common equity using the CAPM as a way of validating the earlier calculations. The risk-free rate of interest is currently 4.1 percent, the market risk premium is estimated to be 5.2 percent, and Hetterbrand's beta is 0.78. What is your estimate of the firm's cost of common equity using this method? (Round to two decimal places.)

Explanation / Answer

Part 1.

Let growth rate be g%.

1.84*(1+g)^4 = 2.24

g = 5%

Dividend to be paid = 2.24*1.05 = 2.352

Cost of common equity = Next Dividend / current price + growth rate

= 2.352/59.17 + 0.05

= 8.98%

Part 2.

Cost of Equity = Risk Free Rate + Beta Coefficient × Market Risk Premium

Cost of Equiy = 4.1 + 0.78 * 5.2

Cost of Equity = 8.16%

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