Problem 9-11 Cost of Equity Radon Homes\'s current EPS is $7.41. It was $4.61 5
ID: 2712952 • Letter: P
Question
Problem 9-11
Cost of Equity
Radon Homes's current EPS is $7.41. It was $4.61 5 years ago. The company pays out 55% 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 = 0.55($7.41) = $4.08). 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 5 yr growth rate = ((EPS today / EPS 5 yrs before) - 1) *100
= ((7.41/4.61) -1 )*100 = 60.74%
2) Current dividend = current EPS * dividend payout = 7.41 *.55 = $4.0755
1 yr growth rate = (1 + 5yr growth rate) ^(1/5) -1 = ( 1 + .6074) ^(.2) -1 = 9.96%
Next year dividend = current dividend * ( 1 + 1 yr growth rate) = 4.0755 * ( 1 + 0.0996 ) = $4.48
3)
Price = Next year dividend/( cost of equity - growth rate)
34 = 4.48 * /(cost of equity - 0.0996)
Cost of equity = 23.14%