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 ​$64.19. The firm just recently paid a dividend of ​$4.04. 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 $58.41 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, rs​, which should equal the cost of retained​ earnings, rr.

D. Using the​ constant-growth valuation​ model, determine the cost of new common​ stock, rn.

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A. The average annual dividend growth rate over the past 5 years is ___ % ​(Round to two decimal​ places.)

Using that growth​ rate, the dividend you expect the company to pay next year is ​$__. ​(Round to two decimal​ places.)

B. The net​ proceeds, Nn​, the firm will actually receive are __ (Round to two decimal​ places.)

C. Using the​ constant-growth valuation​ model, the cost of retained​ earnings, rs​, is __%. ​(Round to two decimal​ places.)

D. Using the​ constant-growth valuation​ model, the cost of new common​ stock, rn​, is __%.​(Round to two decimal​ places)

Answer 1

a) The dividend paid recently by the firm = $ 4.04

The dividend paid by the company 5 years ago =$ 2.99

Total number of years = 5

hence the average annual dividend growth can be calculated as per the formula ,

Gowth(in %) = ((dividend paid recently / dividend paid five years ago)^{1/no. of years} - 1 ) * 100    

=

=

=

=

=

thus the average annual dividend growth rate over the past 5 years = 6.20 %

Dividend recently paid = $ 4.04

average annual dividend growth = 6.20%

thus the next years dividend can be calculated as ,

dividend next year = current dividend + ((current dividend * growth rate)/100)

=

=

=

=

Using the growth rate, the dividend you exppect the company to pay next year is $ 4.29

b) The net proceeds (Nn) are the value or money recieved by the firm after the selling of shares or assets . The flotation cost and the underpricing cost and other miscelleneous cost such as brokerage are subtracted from it and net value is calculated.

As mentioned in the question after the underpricing and floatation costs the firm expects to net $58.41 per share .

So the net proceeds (Nn) the firm will actually recieve is $ 58.41 per share

c) according to constant-growth valuation model,

cost of retained earnings (rs) = (upcoming year's dividend / current stock price ) + (growth rate / 100 )  

= ...............................(as calculated in part a )

=

=

= %

thus, using constant-growth valuation model cost of retained earnings (rs) is 12.88 %

d) Using the onstant-growth valuation model ,

cost of new common stock=(upcoming year's dividend / net price per share on new issue) +(growth rate/ 100)

(actually the formula is = (upcoming year's dividend / new issue price (1- floatation cost)) +(growth rate / 100) but since we are given the new issue share price ($ 58.41 ) which already has the floatation and other costs deducted. we will directly use this new issue price.)

thus ,

cost of new common stock (rs) =

=

=

= %

Thus, using the​ constant-growth valuation​ model, the cost of new common​ stock rn is 13.54%

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