Radon Homes\'s current EPS is $6.94. It was $4.38 5 years ago. The company pays

Question

Radon Homes's current EPS is $6.94. It was $4.38 5 years ago. The company pays out 35% of its earnings as dividends, and the stock sells for $32.

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 = 0.35($6.94) = $2.43). 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

Solution :

Expected return = earnings - price ratio

Expected return 5 years ago = $ 4.38 / $ 32

Expected return 5 years ago = 13.68%

P/E = 1-b/ ( r-g)

32/4.38 = 1 - 0.35 / ( 0.1368 - g)

7.30 = 1 - 0.35 / ( 0.1368 - g)

1 - 7.30 g = 0.65

7.30g = 0.35

g = 4.79%

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The current expected return = $6.94 / $ 32

The current expected return = 21.68%

P/E = 1-b/(r-g)

32 / 6.94 = 1-0.35 / (0.2168 - g)

4.61 = 0.65 / (0.2168 - g)

1-4.61g = 0.65

g = 7.59%

The historical growth rate in earnings = 2.802%

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To Calculate the next expected dividend per share

Expected return = Dividend yield = D1 / P0

0.2168 = d1 / 32

d1 = $ 6.93

The cost of equity is the prospective expected return on this investment = 21.68%

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