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, D1, to be $2.40 and it expects dividends to grow at a constant rate g = 5.6%. The firm's current common stock price, P0, is $27.00. The current risk-free rate, rRF, = 4.8%; the market risk premium, RPM, = 6.1%, and the firm's stock has a current beta, b, = 1.3. Assume that the firm's cost of debt, rd, is 9.51%. The firm uses a 4.1% 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? Round your answers to 2 decimal places.

CAPM cost of equity:	%
Bond yield plus risk premium:	%
DCF cost of equity:	%

Answer 1

Answer:

CAPM Cost of Equity = Risk Free Return + Stock Beta x Market Risk Premium = 4.8% + 1.3 x 6.1% = 12.73%

Bond Yield plus risk premium = Cost of Debt + Risk Premium = 9.51% + 4.1% = 13.61%

DCF (Discounted Cash Flow) Cost of Equity = D1 / P + G

D1 = Next Year expected dividend = $2.40

P0 = Current Market Price of Stock = $27

G = Growth Rate = 5.6% or 0.056

DCF Cost of Equity = $2.40 / $27 + 0.056 = 0.14488 or 14.49%