Cost of common stock equity Ross Textiles wishes to measure its cost of common s
ID: 2745371 • 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 2011-2015, can be found out by solving the following equation for 'g':
3.10 = 2.12(1+g)^4
(3.10/2.12)^1/4 -1 = g
g = 9.97%.
b) # of shares not given to calculate the total proceeds; # shares*$52.
c) Cost of retained earnings = (Next dividend/Current price) + g = (3.4/57.5) + 0.0997 = 0.1588 = 15.88%.
d) Cost of new equity = (Next dividend/Net proceeds per share) + g = (3.4/52) + 0.0997 = 0.1651 = 16.51%.