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# Sidman's & Carpetto Technologies Inc. (Cost of capital questions)

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Q 1. The earnings, dividends, and stock price of Carpetto Technologies Inc. are expected to grow at 7 percent per year into the future. Carpetto's common stock sells for \$23 per share, its last dividend was \$2.00, 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 the cost of equity?

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

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

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

Q2: Sidman's products' stock is currently selling for \$60 per share. The firm is expected to earn \$5.40 per share this year and to pay a year-end dividend of \$3.60.

a. If investors require a 9 percent return what rate of growth must be expected for Sidman?

b. If Sidman reinvests earnings in projects with an average return equal to the stock's expected rate of return, what will be next year's EPS? (Hint: g = ROE (Retention ratio)

Please use Excel if necessary and return solutions in Excel or Word file

#### Solution Preview

Q 1. The earnings, dividends, and stock price of Carpetto Technologies Inc. are expected to grow at 7 percent per year into the future. Carpetto's common stock sells for \$23 per share, its last dividend was \$2.00, 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 the cost of equity?

Ks = D1 / P0 + g = 2.14/23 + .07 = 16.3%

b. If the firm's beta 1.6, the risk free rate is 9 percent, ...

#### Solution Summary

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\$2.19