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11 Feb 2019

2. Compute the cost of common equity using the CAPM model. For beta, use the average beta of three selected competitors. You may obtain the betas from Yahoo Finance. Assume the risk free rate to be 3% and the market risk premium to be 4%.

a. What is the cost of common equity?

b. Explain the advantages and disadvantages to use the CAPM model as the method to compute the cost of common equity. Compare and contrast this method with the dividend growth model approach. (

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Jean Keeling
Jean KeelingLv2
12 Feb 2019

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I have updated this with the appropriate Cost of Debt. Now my I would like to know if my WACC equation is correct?

Data for Hilton Group (HLT)

Equity: Market Cap 18.75 B *found on Yahoo Finance

Debt :

2016 - 10,641,000 *found on Yahoo Finance

2015 – 10,249,00 *found on Yahoo Finance **amount used in WACC calculation due to same number used in Cost of Debt

Annual Report 2015 figures – 9,821,000 *found in annual report – 10K

Risk-Free Rate: .72 *found on Yahoo Finance: Bond Center - 3 month Yield

Market Risk Premium: 5.5% *found in survey – http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2598104 / 7.6 average 1900 - 2004

Dividend Yield: Growth Rate 3.88% *Yahoo Finance, Analysist Estimates – next 5 years

Corporate Tax Rate: 35%

Cost of Equity using CAPM: E(R)= Rf + Beta (Expected Return on Market – Rf) = %

With Survey MRP =0.72+1.35*(5.5-0.72)= 7.173

With Average MRP =0.72+1.35*(7.6-0.72) = 10.08

Cost of Equity using Dividend Discount Model

= 3.88+.35 = 4.23

Cost of Debt:

Weighted Average Interest Rate – 4.2% *found on Hilton.com/quarterly results 2016/fourth quarter 2016 http://ir.hilton.com/~/media/Files/H/Hilton-Worldwide-IR-V3/quarterly-results/2016/q4-2016-earnings-release.pdf

WACC:

5.62% using CAPM cost of equity equation & survey market risk premium (5.5%)

7.43% using CAPM cost of equity equation & average MRP over years (7.6%)

Barton Industries estimates its cost of common equity by using three approaches: the CAPM, the bond-yield-plus-risk-premium approach, and the DCF model. Barton expects next year's annual dividend, D1, to be $2.40 and it expects dividends to grow at a constant rate g = 5.2%. The firm's current common stock price, P0, is $29.00. The current risk-free rate, rRF, = 4.4%; the market risk premium, RPM, = 5.7%, and the firm's stock has a current beta, b, = 1. Assume that the firm's cost of debt, rd, is 8.09%. The firm uses a 3.7% risk premium when arriving at a ballpark estimate of its cost of equity using the bond-yield-plus-risk-premium approach. What is the firm's cost of equity using each of these three approaches? Round your answers to 2 decimal places.

Match the Weighted Average Cost of Capital to each of the scenarios given for ABC Corporation.

- A. B. C. D. E.

Target capital structure: 64% debt, 8% preferred stock and 28% common equity. Yield to maturity on bonds: 4.0%; Preferred stock dividend: $7.44 per year; current market price of preferred stock is $69.94. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 5.6%; ABC has a beta of 1.88. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 71% debt, 6% preferred stock and 23% common equity. Yield to maturity on bonds: 8.8%; Preferred stock dividend: $6.25 per year; current market price of preferred stock is $68.75. CAPM data for common equity: risk-free rate is 4.9%; market risk premium for the average stock is 7.5%; ABC has a beta of 0.92. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 59% debt, 9% preferred stock and 32% common equity. Yield to maturity on bonds: 6.2%; Preferred stock dividend: $6.07 per year; current market price of preferred stock is $68.57. CAPM data for common equity: risk-free rate is 3.4%; market risk premium for the average stock is 9.9%; ABC has a beta of 0.82. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 69% debt, 7% preferred stock and 24% common equity. Yield to maturity on bonds: 8.6%; Preferred stock dividend: $6.14 per year; current market price of preferred stock is $68.64. CAPM data for common equity: risk-free rate is 3.3%; market risk premium for the average stock is 10.5%; ABC has a beta of 0.79. ABC's marginal tax rate is 40%.
- A. B. C. D. E.

Target capital structure: 51% debt, 12% preferred stock and 37% common equity. Yield to maturity on bonds: 5.3%; Preferred stock dividend: $6.71 per year; current market price of preferred stock is $69.21. CAPM data for common equity: risk-free rate is 4.3%; market risk premium for the average stock is 4.5%; ABC has a beta of 1.84. ABC's marginal tax rate is 40%.
A.

7.44%
B.

7.01%
C.

6.97%
D.

6.26%
E.

6.68%

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