The earnings, dividends, and stock price of Carpetto Technologies Inc are expected to grow at 7 percent per year in the future

Cost of equity/The Cost of Capital

The earnings, dividends, and stock price of Carpetto Technologies Inc 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, and the company will pay a dividend of $ 2.14 at the end of the current year.

a. Using the discounted cash flow approach, what is its cost of equity?

rs = D1 + Expected g where D1 is the next expected dividend
Po Po is the stock price
g is the expected growth rate

rs = $2.14 + 7%
$23

rs = 16.30%

b. If the firm's beta is 1.6, the risk free rate is 9%, and the expected return on the market is 13%, what will the firm's cost of equity using the CAPM approach?

Under CAPM approach, we can substitute the values into the CAPM equation to estimate the cost of equity.

rs = rf + (rm - rf)b
rs = 9% + (13% - 9%)1.6
rs = 15.40%

c. If the firm's bonds earn a return of 12%, what will rs be using the bond-yield-plus-risk-premium approach? (Hint: Use the midpoint of the risk premium range.)

First, we need to find the risk premium. As the difference between the risk free rate and the expected return on the market is the risk premium, that is equal to 4 (13 - 9), then the midpoint of the risk premium range is 2.

Then, we can substitute the number into the following equation.

rs = Bond yield + Risk premium
rs = 12% + 2%
rs = 14%

d. On the basis of the results of parts a through c, what would you estimate Carpetto's cost of equity be?

On the basis of the results of parts a through c, the overall average is 15.23% [(16.30% + 15.40% + 14%)/3]. Therefore, I estimate that Carpetto's cost of equity be 15.23%.