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.

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TomShelby TomShelby · Answer 1 · 2020-07-15T02:40:31+02:00

Answer:

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%

Explanation:

We solve for the constant grow rate:

[tex]\frac{Div_0}{(1 + grow)^{time} } = Div_{time}[/tex]

[tex]\frac{2.98}{(1 + grow)^{5} } = 4.05[/tex]

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

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:

[tex]\frac{divends}{return-growth} = Intrinsic \: Value[/tex]

[tex]\frac{divends}{Price} = return-growth[/tex]

[tex]\frac{divends}{Price} + growth = return[/tex]

[tex]$Cost of Equity =\frac{D_1}{P(1-f)} +g[/tex]

D1 4.31

P 45.23

f 0.07

g 0.0633

[tex]$Cost of Equity =\frac{4.31}{45.23(1-0.07)} +0.0633[/tex]

Ke 0.165763157 = 16.57%