Cost of common stock equity Ross Textiles wishes to measure its cost of common s
ID: 2474682 • Letter: C
Question
Cost of common stock equity Ross Textiles wishes to measure its cost of common
stock equity. The firm’s stock is currently selling for $57.50. The firm expects to pay
a $3.40 dividend at the end of the year (2016). The dividends for the past 5 years
are shown in the following table.
Year Dividend
2015 $3.10
2014 2.92
2013 2.60
2012 2.30
2011 2.12
After underpricing and flotation costs, the firm expects to net $52 per share on a
new issue.
a. Determine the growth rate of dividends from 2011 to 2015.
b. Determine the net proceeds, Nn, that the firm will actually receive.
c. Using the constant-growth valuation model, determine the cost of retained earnings, rr.
d. Using the constant-growth valuation model, determine the cost of new common
stock, rn.
Explanation / Answer
a. Growth rate of dividends from 2011 to 2015:
b. Net proceeds = Selling Price of Stock - Price realised after floatation cost and underpricing
= 57.5 - 52
= $5.5
c. Growth rate under constant dividend growth model = (3.40 - 3.10) / 3.1 *100 = 9.68%
Cost of retained earnings (ks) is the return stockholders require on the company's common stock.
ks = D1/P0 + g
= 3.4 / 57.5 + 0.0968
= 15.60%
d. The cost of common equity is same as cost of retained earnings.