Using the chart below, use the constant growth valuation model to calculate Cost
ID: 2646395 • Letter: U
Question
Using the chart below, use the constant growth valuation model to calculate
Cost of retained earnings
Cost of new common stock
Current Mkt
Dividend
Proj Div/share
Underpricing
Flotation
Company
Price / Share
Growth rate
next year
per share
cost/share
1
$20.00
4%
$1.00
$0.50
$1.50
2
$19.00
2%
$2.10
$1.30
$1.70
3
$42.50
6%
$2.00
$1.00
$2.00
4
$50.00
8%
$2.25
$2.00
$1.00
Current Mkt
Dividend
Proj Div/share
Underpricing
Flotation
Company
Price / Share
Growth rate
next year
per share
cost/share
1
$20.00
4%
$1.00
$0.50
$1.50
2
$19.00
2%
$2.10
$1.30
$1.70
3
$42.50
6%
$2.00
$1.00
$2.00
4
$50.00
8%
$2.25
$2.00
$1.00
Explanation / Answer
Cost of equity= Dividend(D)/current price(P0)+growth rate (g)
or
ke=D1/current pricice+g
Company 1 = 1/20+0.04= 9%
company 2 = 2.10/19+0.02=13%
company 3= 2/42.5+0.06=10.70%
company 4= 2.25/50+0.08= 12.5%
Retained Earning= g*return on equity
Company 1= 4*9=3.6%
company 2= 2*13= 2.6%
company 3= 6*10.7=6.42%
company 4 = 8*12.5= 10%
Cost of new common stock = D1/Current Price- Float+growth
Company 1 = 1/20-1.5+0.04=9.40%
company 2= 2.10/(19-1.7)+0.02=14.13%
company3= 2/(42.5-2)+0.06=10.93%
company 4= 2.25/(50-1)+0.08=12.59%
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