Question

P9-10 Cost of common stock equity Ross Textiles wishes to measure its cost of common stock equity. The firm's stock is currently selling for $70.67. The firm just recently paid a dividend of $4. The firm has been increasing dividends regularly. Five years ago, the dividend was just $2.99. After underpricing and flotation costs, the firm expects to net $69 per share on a new issue. a. Determine average annual dividend growth rate over the past 5 years. Report your answer to the nearest whole percentage. Using that growth rate, what divi. dend would you expect the company to pay next year? b. Determine the net proceeds, N., that the firm will actually receive.

Answer 1

Answer a.

Growth Rate = (Last Dividend / Dividend 5 years ago)^(1/5) - 1
Growth Rate = ($4.00 / $2.99)^(1/5) - 1
Growth Rate = 1.0599 - 1
Growth Rate = 0.0599 or 5.99%

Answer b.

Net Proceed, Nn = $69.00

Answer c.

Expected Dividend = Last Dividend * (1 + Growth Rate)
Expected Dividend = $4.00 * 1.0599
Expected Dividend = $4.2396

Cost of Retained Earnings = Expected Dividend / Current Price + Growth Rate
Cost of Retained Earnings = $4.2396 / $70.67 + 0.0599
Cost of Retained Earnings = 0.0600 + 0.0599
Cost of Retained Earnings = 0.1199 or 11.99%

Answer d.

Cost of New Common Stock = Expected Dividend / Net Proceeds + Growth Rate
Cost of New Common Stock = $4.2396 / $69.00 + 0.0599
Cost of New Common Stock = 0.0614 + 0.0599
Cost of New Common Stock = 0.1213 or 12.13%