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Cost of Common Equity Analysis

The document discusses several calculations related to estimating a company's cost of equity. It calculates the cost of equity using the dividend growth model, CAPM, and bond yield plus risk premium approaches. It estimates the cost of equity to be 16.3% based on the bond yield plus risk premium being the most appropriate approach given the available information.

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Ems DelRosario
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3K views2 pages

Cost of Common Equity Analysis

The document discusses several calculations related to estimating a company's cost of equity. It calculates the cost of equity using the dividend growth model, CAPM, and bond yield plus risk premium approaches. It estimates the cost of equity to be 16.3% based on the bond yield plus risk premium being the most appropriate approach given the available information.

Uploaded by

Ems DelRosario
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
  • Stock and Dividend Calculation Problems: This section engages with different stock and dividend calculation problems including approaches to calculating the cost of equity and stock pricing using various methods.
  • Dividend Growth Rate and Stock Valuation: Explores detailed calculations regarding dividend growth rates, expected dividends, and stock valuation methods based on given scenarios and financial models.

11-6. The earnings, dividends, and common stock price of Carpetto Technologies Inc.

are expected to grow at 7 percent per year in the future. Carpetto's common stock sells for $23 per share, its last dividend was $2.00, and it will pay a dividend of $2.14 at the end of the current year. (a) Using the DCF approach, what is the cost of common equity? Cost of common equity Ke = D1/P0 +g D1 = 2.00 (1 + 0.07) = 2.14 Ke = 2.14/23 + 0.07 = 16.30% (b) If the firm's beta is 1.6, the risk-free rate is 9 percent, and the average return on the market is 13 percent, what will be the firm's cost of common equity using the CAPM approach? Required rate of return = Risk free rate + beta x Market risk premium = 9% + 1.6 (13% - 9%) = 15.4% (c) If the firm's bonds earn a return of 12 percent, what will r s be based on the bond-yield-plus-riskpremium approach, using the midpoint of the risk premium range? Rs= Bond yield + Risk premium =12%+4% =16% (d) Assuming you have equal confidence in the inputs used for the three approaches, what is your estimate of Carpetto's cost of common equity? 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% 11-7. Where: D1 = $3.18; g = 6%; PV EPS = $36; FV external equity (new stock) EPS = $32.40. We find rs, F, and re: a) Cost of retained earnings; rs: rs = D1 / Po + g = 3.18 / 36 + 0.06 = 14.83 % b) Flotation cost; F: F = PV of EPS FV of EPS / PV of EPS = 36 32.40 / 36 = 0.1 = 10% c) Cost of new common stock; re; where Po(1-F) is represented by external equity of $32.40: = D1 / Po(1-F) + g = 3.18 / 32.40 + 0.06 = 0.098148 + 0.06 = 0.15814 = 15.81% 11-13 Maximum sustainable growth rate g is a "given" at 12% and can be confirmed using ROE x (1 - payout ratio) = 0.16 x 0.75 = 0.12

flotation cost = 46.75 * 0.05 = 2.3370 proceeds after flotation cost = 46.75 - 2.3370 = 44.1250 (2.3370 / 44.1250) + growth rate 0.12 = 0.05263 + 0.12 = 0.17263 or about =17.26% 11-16. (a) Calculating Dividend Growth Rate: Future value of EPS (FV) Present Value of EPS (PV) Number of years (n) PV of EPS / FV of EPS = $4.42 / $6.50 = 0.68 Present Value factor for 5 years Interest rate Dividend Growth rate = 8% (b) Last dividend(D0) = $2.60 Expected Dividend (D1) = $2.60 * (1+0.08) D1 =$2.81 (c) Cost of retained earnings(ks) = (D1 / P0) + g = ($2.81/ $36) + 0.08 = 0.158(or) 15.81% Cost of retained earnings (ks) =15.81% 11-17. The current srock price (P0)=$60 (D1)=$3.60 (a) If investor reqiure(rs) 9% return = [(D1)/(P0)]+g 0.09 = [3.60/60]+g g = 0.09-0.06 = 0.03 or 3% There fore growth rate needed to meet 9% reuired rate(rs) is equals to 3% ______________________________________________________________________________ (b)If invstor reinvest the earningg in the same project the next year EPS Would be rs = 9% g =0.03 pecent D1=$5.40 The standard formula rs = [(D1)/(P0)]+g 0.09 = [$5.40/P 0]+0.03 [ 5.40/P0] = 0.09-0.03 P0(Next year) = $5.40/0.06 P0 (Next year) = $90 EPS = ENDING PRICE-BEGINIG PRICE = $90-$60 = $30

$6.50 $4.42 5 years 0.68 8%

11-6. The earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow at 7 percent per y
flotation cost = 46.75 * 0.05 = 2.3370 proceeds after flotation cost = 46.75 - 2.3370 = 44.1250 (2.3370 / 44.1250) + gr

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