4. P9-10: Cost of common stock equity, p. 385 Ross Textiles wishes to measure it

Question

4. P9-10: Cost of common stock equity, p. 385

      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 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

Solution a:

The growth rate of dividend would be :

Solution B:

The ned proceeds that the firm will actually receive = dividend + per shre value 3.4 + 52 = $55.4

Solution c:

Constant growth valuation model = Kr = Dividend/Price + G

Kr = 3.4 / 57.50 + 9.94%

Growth is the average of 5 years growth rate

hence Kr = .0591+.0994

Kr = 15.85%

Cost of new common stock = 3.4/52 +.0994

.0653+.0994 = 16.47%

2016 2015 2014 2013 2012 2011 Dividend 3.4 3.1 2.92 2.6 2.3 2.12 Growth rate per annum = 2012- 2011 /2011 0.097 0.062 0.123 0.130 0.085 9.70% 6.20% 12.30% 13% 8.50%

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