LaForge\'s common stock is currently selling for $50 a share. Its last dividend

Question

LaForge's common stock is currently selling for $50 a share. Its last dividend was $4.19, and dividends are expected to grow at a constant rate of 5% in the forseeable future. LaForge's beta is 1.2, and its yield on a T-bond is 5%, and the market risk premium is estimated at 5%. For the bond yield plus risk premium approach, use a maximum risk premium.

A. What is LaForge's estimated cost of common equity based on the CAPM approach?

B. What is LaForge's estimated cost of common equity using the DCF approach?

C. What is the bond yield plus risk premium estimate to LaForge's cost of common equity?

Explanation / Answer

CAPM Cost of equity = Risk free rate + Beta * ( Market risk premium ) = 5% + 1.2 *5% = 11%

COst of Equity using DCF approach = D1/Current Price + Growth Rate where D1 = D0(1 +g)

= 4.19( 1 + 5%)/50 + 5% = 13.80%

Bond Yield Plus Risk premium = Yield on Corporate Bond + Market risk premium = 5% + 5% = 10%

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