Problem 11-11 Cost of Equity Radon Homes\'s current EPS is $6.46. It was $4.09 5

Question

Problem 11-11 Cost of Equity Radon Homes's current EPS is $6.46. It was $4.09 5 years ago. The company pays out 40% of its earnings as dividends, and the stock sells for $35 a. Calculate the historical growth rate in earnings. Round your answer to two decimal places. (Hint: This is a 5-year growth period.) b. Calculate the next expected dividend per share, D1 Assume that the past growth rate will continue. Round your answer to the nearest cent. (Hint: Do0.40($6.46)-$2.58) c. What is Radon's cost of equity, rs? Round your answer to two decimal places.

Explanation / Answer

EPS (t = -5) = 4.09

EPS (t = 0) = 6.46

g = (6.46/4.09)^(1/5) – 1 = 0.095726

Historical growth rate in earnings = 9.57%

D1 = D0*(1 + g) = EPS*POR*(1 + g)

Now, final value depends on whether you use truncated g.

D1 = 6.46*0.4*1.095726 = $2.83

Now, use gordon discount model

r = D1/P0 + g = 2.83/35 + 0.095726 = 0.1766

Cost of equity = 17.66%

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