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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

09 = [3.03 [ 5.05263 + 0.08 = 0.1250) + growth rate 0.06 = 0.1250 (2. The current srock price (P0)=$60 (D1)=$3.3370 = 44.12 = 0.81/ $36) + 0.40/P0] = 0.17263 or about =17.40/0.75 .09-0.40/P 0]+0.26% 11-16.03 pecent D1=$5.05 = 2.42 / $6. (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 = $4.81 (c) Cost of retained earnings(ks) = (D1 / P0) + g = ($2.2.60 Expected Dividend (D1) = $2.03 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 =0.81% Cost of retained earnings (ks) =15.158(or) 15.50 = 0.09-0.68 Present Value factor for 5 years Interest rate Dividend Growth rate = 8% (b) Last dividend(D0) = $2.flotation cost = 46.68 8% .60 * (1+0.75 * 0.60/60]+g g = 0.09 = [$5.42 5 years 0.50 $4.06 P0 (Next year) = $90 EPS = ENDING PRICE-BEGINIG PRICE = $90-$60 = $30 $6.03 P0(Next year) = $5.08) D1 =$2.3370 proceeds after flotation cost = 46.81% 11-17.40 The standard formula rs = [(D1)/(P0)]+g 0.12 = 0.3370 / 44.60 (a) If investor reqiure(rs) 9% return = [(D1)/(P0)]+g 0.

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