Question

Quesdon Help Cost of common stock equity Ross Textiles wishes to measure its cost of common stock equity. The firm's stock is currently selling for $50.45. The fim just recently paid a dividend or 4. 11. The firm has been increasing divideryds regularly. Five years ago, the dividend was just $2.97 After underpricing and lotion costs, the fem expects to net 544 40 per share on a new issue a. Determine average annual dividend growth rate over the past 5 years. Using the growth rate, what dividend would you expect the company to pay next year? b. Determine the proceeds, N, that the firm will actually receive c. Using the constant growth valuation model determine the required return on the company's stock, ig, which should equal the cost of retained earnings d. Using the contgrowth valuation model, determine the cost of new common stock. In

Answer 1

a. average annual dividend growth rate = (ending dividend/beginning dividend)^{1/no. of years} - 1

average annual dividend growth rate = ($4.11/$2.97)^1/5 - 1 = (1.3838383838383838383838383838384)^0.2 - 1 = 1.06712937393064131212741094999 - 1 = 0.0671 or 6.71%

expected dividend next year = last dividend paid*(1+ average annual dividend growth rate) = $4.11*(1+0.0671) = $4.11*1.0671 = $4.385781 or $4.39

b. the net proceeds that the firm will actually receive is $44.40 per share on new issue. underpricing and flotation cost will reduce the new share issue price below the current share price.

c. required return = (expected dividend next year/current share price) + average annual dividend growth rate

required return = ($4.385781/$50.45) + 0.0671 = 0.08693322101090188305252725470763 + 0.0671 = 0.1540 or 15.40%

d. Cost of new common stock = (expected dividend next year/net proceeds from new issue) + average annual dividend growth rate

Cost of new common stock = ($4.385781/$44.40) + 0.0671 = 0.09877885135135135135135135135135 + 0.0671 = 0.1659 or 16.59%