# Cost of Common Equity The future earnings, dividends, and a common stock price of Carpetto...

## Question:

Cost of Common Equity

The future earnings, dividends, and a common stock price of Carpetto Technologies Inc. are expected to grow 5% per year. Carpetto's common stock currently sells for $21.00 per share; its last dividend was$2.20, and it will pay a \$2.31 dividend at the end of the current year.

Using the DCF approach, what is its cost of common equity? Round your answer to two decimal places. %

If the firm's beta is 1.30, the risk-free rate is 8%, and the average return on the market is 14%, what will be the firm's cost of common equity using the CAPM approach? Round your answer to two decimal places. %

If the firm's bonds earn a return of 10%, based on the bond-yield-plus-risk-premium approach, what will be rs? Use the midpoint of the risk premium range discussed in Section 10-5 in your calculations. Round your answer to two decimal places. %

If you have equal confidence in the inputs used for the three approaches, what is your estimate of Carpetto's cost of common equity? Round your answer to two decimal places. %

## Cost of equity:

Cost of equity is the cost of financing through the common stockholders of the company. Financing through common stockholders result in giving up a stake of the company. It can be calculated as per several methods, such as the Dividend growth model, CAPM or capital asset pricing model, etc.

Cost of equity as per DCF approach is
= Next dividend / Current price x 100
= 2.31 / 21 + 0.05
= 0.16
= 16%

Cost of equity as per CAPM
= Risk free rate + (Market return - Risk free rate) x Beta
= 8% + (14% - 8%) x 1.30
= 15.80%

Cost of equity as per bond-yield-plus-risk-premium-approach
= Bond yield + Risk premium
= 10% + 7.80% = 17.80%

• Since no range of risk premium is given, the risk premium from the CAPM model return is taken.
• Risk premium = Stock return - Riskfree rate = 15.80% - 8% = 7.80%

Now, If we have equal confidence, then Cost of equity = 16% x 1/3 + 15.80% x 1/3 + 17.80% x 1/3 = 16.53% 