In: Finance
The future earnings, dividends, and common stock price of Callahan Technologies Inc. are expected to grow 4% per year. Callahan's common stock currently sells for $26.50 per share; its last dividend was $2.00; and it will pay a $2.08 dividend at the end of the current year.
Requirement (a) – Cost of Common Equity using DCF Approach
Dividend in year 1 (D1) = $2.08 per share
Current selling price per share (P0) = $26.50 per share
Dividend growth Rate (g) = 4.00% per year
Therefore, the Cost of Common Equity = [D1 / P0] + g
= [$2.08 / $26.50] + 0.04
= 0.0785 + 0.04
= 0.1185 or
= 11.85%
“The Cost of Common Equity = 11.85%”
Requirement (b) – Cost of Common Equity using CAPM Approach
Cost of Common Equity using CAPM Approach = Rf + Beta[Rm – Rf]
= 5.00% + 1.0[14.00% - 5.00%]
= 5.00% + [1.0 x 9.00%]
= 5.00% + 9.00%
= 14.00%
“Cost of Common Equity = 14.00%”
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
= 12.00% + 4.00%
= 16.00%
“Therefore, The “Rs = 16.00%”
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 = [11.85% + 14.00% + 16.00%] / 3
= 41.85% / 3
= 13.95%
“Callahan's cost of common equity = 13.95%”