   Chapter 10, Problem 2TCL Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

CALCULATING 3M’s COST OF CAPITALIn this chapter, we described how to estimate a company’s WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining & Manufacturing’s (MMM) WACC.2. Once again we can use the CAPM to estimate MMM’s cost of equity. From the Internet, you can find a number of different sources for estimates of beta—select the measure that you think is best, and combine this with your estimates of the risk-free rate and the market risk premium to obtain an estimate of its cost of equity. (See the Taking a Closer Look problem in Chapter 8 for more details.) What is your estimate for MMM’s cost of equity? Why might it not make much sense to use the DCF approach to estimate MMM’s cost of equity?

Summary Introduction

To determine: The estimate for the cost of equity of M company and the criticism for the DCF approach to evaluate the cost of equity.

Introduction:

Cost of Equity:

The cost of equity refers to that return which a firm pays to the investors in return for the risk they take by investing the capital in this firm.

Explanation

Explanaion:

The estimate of the cost of equity by Capital Asset Pricing Model (CAPM):

The formula used as per CAPM is,

rs=rrf+bi×(rmrrf)

Where,

• rs is the cost of equity.
• rrf is the risk-free rate.
• bi is the value of the beta.
• rm is the market return.

Substitute 2.78% for rrf , 6% for rm and 1

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