COST OF COMMON STOCK EQUITY: Ross textiles wishes to measure its cost of common
ID: 2772530 • Letter: C
Question
COST OF COMMON STOCK EQUITY: Ross textiles wishes to measure its cost of common stock equity. The firms 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 understanding 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 recieve
C.) Using the constant-growth vakuation 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 of Dividends from 2011 to 2015 =G= (Dividend2015-Dividend2011)/Dividend2011
Dividend2015=3.10, Dividend2011=2.12
=>G= (3.10-2.12)/2.12 =.98/2.12 = 0.4623= 46.23%
Therefore % growth rate(g) of Dividends from 2011 to 2015= Average of %growth of Dividends from 2011 to 2015
=>g= G/4= 46.23%/4= 11.5575% is the average growth rate or growth % per year of Dividends over the years 2011 to 2015. Thus growth rate of dividends from 2011 to 2015 =g =11.5575%
C) constant-growth valuation model, current Price of stock=P0= Dividend by year end/(rr-g) =D1/(rr-g) where rr is the cost of retained earnings , g is the growth rate of dividends in %
So , P0=D1/(rr-g) => rr-g=D1/P0 => rr=(D1/P0)+g
put values,D1= 3.40 ,g= 11.5575% ,P0=57.50
pu this value in above equation of rr=(D1/P0)+g=> rr =(3.40 /57.50)+.115575 =0.05913+.115575 = 0.174705 or 17.47%
D) By constant-growth valuation model, issue price of stock=P0=D1/(rn-g)
P0=$52 other inputs same as in C,
Derive same formula as in C, rn=(D1/P0)+g = (3.40 /52)+.115575 =0.06539 +.115575= 0.180965 or 18.097%
In B) i think insufficient information is provided, net proceeds cant be calculated as per info given.