Question

Procter and Gamble (PG) has a June fiscal year-end. On June 30, 2006, analysts expected the company to pay $1.33 dividends per share in fiscal year 2007. The company's market beta is estimated to be 0.7. Assume that the risk-free rate is 5.7% and the market premium is 5%. During fiscal year 2006, the company's sales growth was 20.2%. However, analysis reveals that P&G's fiscal 2006 sales include eight months of sales from Gillette after its acquisition by P&G during 2006. Footnotes report pro forma sales that show what the income statement would have reported had Gillette's full-year sales been included in both 2005 and 2006—specifically, P&G's sales growth would have been 4.4%.

(a) Estimate P&G's cost of equity capital using the CAPM model. (Round your answer to one decimal place.)

Answer 1

9.2%

Step-by-step explanation:

CAPM is short for capital asset pricing model. This is a technique of valuing the cost of capital that uses the stock's beta( a measure of the stock's volatility in the market), the risk-free and market rates.

CAPM =
`R_(f)` +
`\beta`(
`R_(m)`-
`R_(f)`

Given,

Risk-free rate,
`R_(f)` = 5.7%

Beta,
`\beta` =0.7

Market premium,
`M_(p)` = 5%

Thus, using CAPM.

P&G's cost of equity capital = 5.7% + 0.7(5%)

= 5.7% + 3.5%

= 9.2%