Cost of Equity Radon Homes\'s current EPS is $7.21. It was $4.95 5 years ago. Th
ID: 2650824 • Letter: C
Question
Cost of Equity
Radon Homes's current EPS is $7.21. It was $4.95 5 years ago. The company pays out 35% of its earnings as dividends, and the stock sells for $34.
Calculate the historical growth rate in earnings. (Hint: This is a 5-year growth period.) Round your answer to two decimal places.
%
Calculate the next expected dividend per share, D1 (Hint: D0 = 0.35($7.21) = $2.52). Assume that the past growth rate will continue. Round your answer to the nearest cent.
$
What is Radon's cost of equity, rs? Round your answer to two decimal places.
%
Explanation / Answer
1) Historical growth rate in earnings = (Ending Value / Beginning Value)1/n - 1 = (7.21 / 4.95)1/5 - 1 = 7.81%
2) Today's Dividend(D0) = 7.21 x 0.35 = $2.52
Next Year Dividend(D1) = 2.52 x 107.81% = $2.72
3) Cost of Equity (using Dividend Growth Model) = D1/P0 + g = (2.72/34) + 0.0781 = 0.1581 or 15.81%