Question

Quantitative Problem: Barton Industries estimates its cost of common equity by using three approaches: the CAPM, the bond-yield-plus-risk- premium approach, and the DCF model. Barton expects next year's annual dividend, Du, to be $2.10 and it expects dividends to grow at a constant rate OL - 5.8%. The firm's current common stock price, Po, is $29.00. The current risk-free rate, ref, - 4.3%; the market risk premium, RPM,- 5.6%, and the firm's stock has a current beta, b, - 1.1. Assume that the firm's cost of debt, rd, is 8.15%. The firm uses a 3.6% risk premium when arriving at a ballpark estimate of its cost of equity using the bond-yield-plus-risk.premium approach. What is the firm's cost of equity using each of these three approaches? Do not round intermediate calculations. Round your answers to 2 decimal places. CAPM cost of equity: Bond-Yield-Plus-Risk-Premium: DCF cost of equity:

Answer 1

Please find the answer below:

CAPM = +
Birm -rf)

where rf =risk free rate, B = beta coefficient of security, rm = market rate of return

= 4.3% + 1.1 (5.6% - 4.3%)

=5.73%

Bond yield plus risk premium

= rd + risk premium

where rd = cost of debt , risk premium = amount needed for addition risk in equity as compared to debt

= 8.5%+3.6% = 12.1%

DCF cost of equity

= (Next year dividend per share / current price of stock) + growth rate of dividends

= (2.1/29)+0.058

= 13.04%

Hope this helps!!