Cost of Equity Payton Homes\'s current EPS is $7.95. It was $3.63 5 years ago. T
ID: 2654343 • Letter: C
Question
Cost of Equity
Payton Homes's current EPS is $7.95. It was $3.63 5 years ago. The company pays out 35% of its earnings as dividends, and the stock sells for $32.
A) Calculate the historical growth rate in earnings. (Hint: This is a 5-year growth period.) Round your answer to two decimal places.
B) Calculate the next expected dividend per share, D1 (Hint: D0 = 0.35($7.95) = $2.78). Assume that the past growth rate will continue. Round your answer to the nearest cent.
C) What is Payton's cost of equity, rs? Round your answer to two decimal places.
Explanation / Answer
Answer:
A) Calculation of historical growth rate in earnings:
Growth rate(g) = (Current EPS / EPS EPS before 5 years)^(1/5) -1
=(7.95 / 3.63)^(1/5) -1
= (2.1900826)^(1/5) -1
=0.1697
=16.97%
B) Calculation of next expected dividend per share (D1)
D1 = D0 * (1+g)
Current Dividend (D0) = Current EPS *Payout ratio
=7.95 *35% =$2.78
Hence D1 = 2.78 * (1+0.1697) = $3.25
C) Calculation of Cost of Equity :
Cost of Equity = (D1 /P0 ) +g
Current Price (P0) =$32
Hence Cos of Equity = (3.25 /32) + 0.1697
= 0.2713
= 27.13%