Cost of equity-problem 9-11 Radon Homes current EPS is $6.50. It was $4.42 five
ID: 2713731 • Letter: C
Question
Cost of equity-problem 9-11
Radon Homes current EPS is $6.50. It was $4.42 five years ago. The company pays out 40% of its earnings as dividends and the stock sells for $36.
(a) Calculate the historical growth rate in earnings (hint this is a 5-year growth period.) Answer is 8%--show all work and formulas to support answer
(b) Calculate the next expected dividend per share D1. (Hint Do = 0.4 ($6.50) = $2.60.) Assume that the past growth rate will continue. Answer is $2.81 show all work and formulas
(c) What is Radon's cost of equity, rs? Answer is 15.81% show all work and formulas.
Explanation / Answer
a)
Historical growth:
= (Current dividend÷dividend 5 year ago)^(1÷5)-1
= [($6.5×0.40)÷($4.42×0.40)]^(1÷5)-1
= 8%
b)
Next expected dividend:
= $6.50×0.40×(1+8%)
= $2.81
c)
Stock price = D1÷(r-g)
D1 is next expected dividend
r is required return
g is growth rate
$36 = $2.81÷(r-8%)
Cost of equity, r = 15.81%