Question

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am’s Fine Garments sells jackets and sports coats in suburban malls throughout the country. Business has...

am’s Fine Garments sells jackets and sports coats in suburban malls throughout the country. Business has been good, as indicated by the ten-year growth in earnings per share. The earnings have grown from $1.00 to $3.10. (Use a Financial calculator to arrive at the answers.)

a. Determine the compound annual rate of growth in earnings (n = 10). Use Appendix A. (Round the final answer to 2 decimal places.)

Compound annual rate of growth %

b. Based on the growth rate determined in part a, project earnings for next year (E₁). (Round compound annual rate of growth to 2 decimal places. Round the final answer to 2 decimal places.)

E₁$

c. Assume the dividend payout ratio is 15 percent. Compute D₁. (Round intermediate calculations to 2 decimal places. Round the final answer to 2 decimal places.)

D₁ $

d. The current price of the stock is $11. Using the growth rate (g) from part a and D₁ from part c, compute K_e. (Round compound annual rate of growth to 2 decimal places. Round the final answer to 2 decimal places.)

K_e %

e. If the flotation cost is $1.50, compute the cost of new common stock (K_n). (Round compound annual rate of growth to 2 decimal places. Round intermediate calculations to 2 decimal places. Round the final answer to 2 decimal places.)

K_n %

Solutions

Expert Solution

Compound annual rate of growth = (Future value / initial value)^1/n - 1

Compound annual rate of growth = (3.1 / 1)^1 / 10 - 1

Compound annual rate of growth = (3.1)^1/10 - 1

Compound annual rate of growth = 1.1198 - 1

Compound annual rate of growth = 0.1198 or 11.98%

Next year earnings = Current year earnings (1 + growth rate)

Next year earnings = 3.1 (1 + 0.1198)

Next year earnings = $3.47

D1 = Dividend payout ratio * next year earnings

D1 = (15 / 100) * 3.47

D1 = 0.52

Ke = (Dividend in year 1 / price) + growth rate

Ke = (0.52 / 11) + 0.1198

Ke = 0.04727 + 0.1198

Ke = 0.1671 or 16.71%

Price after flotation cost = 11 - 1.5 = 9.5

Cost of new common stock = (Dividend in year 1 / price) + growth rate

Cost of new common stock = (0.52 / 9.5) + 0.1198

Cost of new common stock = 0.1745 or 17.45%

jeff jeffy answered 2 years ago

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