In: Finance
The future earnings, dividends, and common stock price of Callahan Technologies Inc. are expected to grow 6% per year. Callahan's common stock currently sells for $21.50 per share; its last dividend was $2.00; and it will pay a $2.12 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 1.3, the risk-free rate is 7%, 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 8%, based on the
bond-yield-plus-risk-premium approach, what will be rs?
Use the midpoint of the risk premium range. 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 Callahan's cost of common
equity?. Round your answer to two decimal places.
%
Requirement (a) – Cost of Common Equity using DCF Approach
Dividend in year 1 (D1) = $2.12 per share
Current selling price per share (P0) = $21.50 per share
Dividend growth Rate (g) = 6.00% per year
Therefore, the Cost of Common Equity = [D1 / P0] + g
= [$2.12 / $21.50] + 0.06
= 0.0986 + 0.06
= 0.1586 or
= 15.86%
Requirement (b) – Cost of Common Equity using CAPM Approach
Cost of Common Equity using CAPM Approach = Risk-free Rate + Beta(Market Rate of Return – Risk-free Rate)
= Rf + Beta[Rm – Rf]
= 7.00% + 1.30[14.00% - 7.00%]
= 7.00% + [1.30 x 7.00%]
= 7.00% + 9.10%
= 16.10%
Requirement (c) – Cost of Common Equity Bond Yield Risk Premium Approach
The appropriate risk premium discussed in section 10-5 is from 3% to 5%. Therefore, the mid-point of the range is 4%
Therefore, The Cost of Common Equity Bond Yield Risk Premium Approach = Return of the Bond + Mid-point of the range
= 8.00% + 4.00%
= 12.00%
Requirement (d) – Cost of common equity using equal confidence
Using Equal Confidence, the cost of common equity would be the average of the cost of common equity calculated under the above 3 alternatives,
Cost of Common Equity = [15.86% + 16.10% + 12.00%] / 3
= 43.96% / 3
= 14.65%