6. Reynolds Textiles wants to measure its cost of common equity. The firm’s stoc
ID: 2668021 • Letter: 6
Question
6. Reynolds Textiles wants to measure its cost of common equity. The firm’s stock is currently selling for $57.50 per share. The firm expects to pay a $3.40 dividend at the end of 2011 (so assume that
D1 = $3.40 for purposes of calculation). The dividends for the last 5 years are as follows:
Year Dividend
2010 $3.10
2009 $2.92
2008 $2.60
2007 $2.30
2006 $2.12
After incurring flotation costs, Reynolds Textiles expects to net $52 per share on a new issue.
(a) Determine the growth rate of dividends (g).
(b) By applying the constant-growth valuation model, determine the cost of retained earnings common equity (rs).
(c) By applying the constant-growth valuation model, determine the cost of newly-issued common equity (re).
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Explanation / Answer
(a) Growth rate of dividend: D1 = D0(1+g)^1 Here D1 is $3.40. then D0 is $3.10 $3.40 = $3.10(1+g) (1+g) = 3.40/3.10 = 1.0967 g = 0.0967 Growth rate is 9.67%. Therefore dividend growth rate is 9.67%. (b) Cost of retained earnings common equity = Dividend/Mareket price + growth rate = 3.40/57.50 + 9.67% = 0.0591 + 9.67% = 5.91% + 9.67% = 15.58% Cost of retained earings common equity is 15.58%. (c) Newly issued common equity = Dividend/Net proceeds + Growth rate = 3.40/52 + 9.67% = 0.065 + 9.67% = 6.5% + 9.67% = 16.67% Cost of newly issued common equity is 16.67% D1 = D0(1+g)^1 Here D1 is $3.40. then D0 is $3.10 $3.40 = $3.10(1+g) (1+g) = 3.40/3.10 = 1.0967 g = 0.0967 Growth rate is 9.67%. Therefore dividend growth rate is 9.67%. (b) Cost of retained earnings common equity = Dividend/Mareket price + growth rate = 3.40/57.50 + 9.67% = 0.0591 + 9.67% = 5.91% + 9.67% = 15.58% Cost of retained earings common equity is 15.58%. (c) Newly issued common equity = Dividend/Net proceeds + Growth rate = 3.40/52 + 9.67% = 0.065 + 9.67% = 6.5% + 9.67% = 16.67% Cost of newly issued common equity is 16.67%Related Questions
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