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 ​$45.23. The firm just recently paid a dividend of ​$4.05. The firm has been increasing dividends regularly. Five years​ ago, the dividend was just ​$2.98. After underpricing and flotation​ costs, the firm expects to net ​$42.06 per share on a new issue. a. Determine average annual dividend growth rate over the past 5 years. Using that growth​ rate, what dividend would you expect the company to pay next​ year? b. Determine the net​ proceeds, Nn​, that the firm will actually receive. c. Using the​ constant-growth valuation​ model, determine the required return on the​ company's stock, r Subscript s​, which should equal the cost of retained​ earnings, r Subscript r. d. Using the​ constant-growth valuation​ model, determine the cost of new common​ stock, r Subscript n.

Answer 1

A)grow = 6.33%

Nxt year dividends(rounded to nearest cent): $4.31

B) The firm receives 93% (1 - flotation cost) of the market value of the shares so It receives the 42.06 per share

C) stock return 15.86%

D) required rate of return (with flotation): 16.57%

Step-by-step explanation:

We solve for the constant grow rate:

`(Div_0)/((1 + grow)^(time) ) = Div_(time)`

`(2.98)/((1 + grow)^(5) ) = 4.05`

`grow= \sqrt[5]{4.05/2.98} -1`

grow= 0.063280262

Dividends for the sixth year:

4.05 x (1.0633) = 4,306365

42.06 / (1 - flotation cost) = 45.23

flotation cost = 1 - 42.06 / 45.23 = 0.07 = 7%

rate of return without flotation:

4.31/45.23 + 0.0633 = 0.158590736 = 15.86%

solving for return considering the existence of flotation cost:

`(divends)/(return-growth) = Intrinsic \: Value`

`(divends)/(Price) = return-growth`

`(divends)/(Price) + growth = return`

`$Cost of Equity =(D_1)/(P(1-f)) +g`

D1 4.31

P 45.23

f 0.07

g 0.0633

`$Cost of Equity =(4.31)/(45.23(1-0.07)) +0.0633`

Ke 0.165763157 = 16.57%