COST OF COMMON EQUITY The future earnings, dividends, and common stock price of

Carpetto Technologies Inc. are expected to grow 7% per year. Carpettos common stock
currently sells for $23.00 per share; its last dividend was $2.00; and it will pay a $2.14
dividend at the end of the current year.
a. Using the DCF approach, what is its cost of common equity?
b. If the firms beta is 1.6, the risk-free rate is 9%, and the average return on the market is
13%, what will be the firms cost of common equity using the CAPM approach?
c. If the firms bonds earn a return of 12%, 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.
d. If you have equal confidence in the inputs used for the three approaches, what is your
estimate of Carpettos cost of common equity

Stock Price 23
G 7%
D0 2
DI 2.14

a. Using the DCF approach, what is its cost of common equity?

Rs=D1/P0+g
Rs P0
D1 2.14
PO 23
G 7%
Rs=D1/P0+g 16.30%

b. If the firms beta is 1.6, the risk-free rate is 9%, and the average return on the market is
13%, what will be the firms cost of common equity using the CAPM approach?

B 1.6
Rrf 9%
Rm 13%

Rs=Rrf+(Rm-Rrf)b 15.40%

c. If the firms bonds earn a return of 12%, 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.

rD 12%
Rrf 9%
Rm 13%

Rs=Rd+RP 16.00%
d. If you have equal confidence in the inputs used for the three approaches, what is your
estimate of Carpettos cost of common equity

WACC 15.90%
CAPM Rs=Rrf+(Rm-Rrf)b

DCF Rs=D1/P0+g

Bond Yield Plus Risk Premium Rs=Rd+RP

COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION The Evanec Companys
next expected dividend, D1, is $3.18; its growth rate is 6%; and its common stock now sells
for $36.00. New stock (external equity) can be sold to net $32.40 per share.
a. What is Evanecs cost of retained earnings, rs?
b. What is Evanecs percentage flotation cost, F?
c. What is Evanecs cost of new common stock, re?

D1 3.18
g 6%
CS 36

MP 32.4

F 10

Rs=D1/P0+g 14.83%

Re=D0(1+g)/P0(1-F)+g

Re 3.18
32.4
9.8148148148
15.8148148148

Rs 14.83
F 10%
Re 15.81%
COST OF COMMON EQUITY AND WACC Patton Paints Corporation has a target capital
structure of 40% debt and 60% common equity, with no preferred stock. Its before-tax cost
of debt is 12%, and its marginal tax rate is 40%. The current stock price is P0 $22.50. The
last dividend was D0 $2.00, and it is expected to grow at a 7% constant rate. What is its
cost of common equity and its WACC?

Debt 0.4
Equity 0.6

Tax Rate 40%

CM 22.5
D0 2 D1 2.14
g 7%
Rd 0.12
Rs 16.51%

WACC WdRd(1-Tax Rate)+WcRs

WdRd(1-TR) 0.0288
WcRs 0.09906
WACC 12.79%
WACC The Patrick Companys cost of common equity is 16%, its before-tax cost of debt is
13%, and its marginal tax rate is 40%. The stock sells at book value. Using the following
balance sheet, calculate Patricks WACC.

RS 16%
Tas 40%
RD 13%

LTD 1152 CE 1728

DEBT 0.4
Equity 0.6

WACC

WdRd 0.052
WdRd(1-TR 0.0312
WcRs 0.096

WACC 12.72%
CAPITAL BUDGETING CRITERIA Your division is considering two projects. Its WACC is
10%, and the projects after-tax cash flows (in millions of dollars) would be as follows:

WACC 10%
0 1 2 3 4
Project A -30 5 10 15 20
Project B -30 20 10 8 6

Cumulative A -30 -25 -15 0 20

Cumulative A -30 -10 0 8 14

a. Calculate the projects NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks.

NPVa $7.04 $2.79

NPVb $5.96 $3.17

IRRa 19.19%
IRRb 22.52%

MIRRa 16.50%
MIRRb 15.57%

Regular Payback a 3Y
Regular Payback b 2Y

Discounted Payback 0 1 2 3 4
Project A -30 5 10 15 20
Project B -30 20 10 8 6

PV Of Cva ($30.00) $4.55 $8.26 $11.27 $13.66

PV Of CVb ($30.00) $18.18 $8.26 $6.01 $4.10

CMV of Pva ($30.00) ($25.45) ($17.19) ($5.92) $7.74

CMV of Pvb ($30.00) ($11.82) ($3.55) $2.46 $6.55

Discounted Payback-a 3.4

Discounted Payback-b 2.6

Project A Project B
NPV 7.04 5.96
IRR 19.19% 22.52%
MIRR 16.50% 15.57%
Payback Period 3 Years 2 Years
Discounted PayBack 3.4 Years 2.6 Years
b. If the two projects are independent, which project(s) should be chosen?
Project A & B

c. If the two projects are mutually exclusive and the WACC is 10%, which project(s)
should be chosen?
Project A

e. If the WACC was 5%, would this change your recommendation if the projects were
mutually exclusive? If the WACC was 15%, would this change your recommendation?

At 5% I would not change my reccomendation but @15 % Project B is more profitable.

h. Now look at the regular and discounted paybacks. Which project looks better when
judged by the paybacks?
Project B
-1