Textiles wishes to measure its cost of common stock equity. The? firm's stock is currently selling for ?$66.78. The firm just recently paid a dividend of ?$3.95. 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 ?$58.10 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.

 

The solution to the above questions is as follows:

Step-by-step explanation

a).

Dividend last year = $3.95

Dividend five years ago = $2.98

Growth rate = (Dividend last year / Dividend five years ago)^(1/5) - 1

Growth rate = ($3.95 / $2.98)^(1/5) - 1

Growth rate = 1.325503^(1/5) - 1

Growth rate = 1.05798 - 1

Growth rate = 0.05798

Therefore, growth rate= 5.798%

Expected dividend = Dividend last year * (1 + Growth rate)

Expected dividend = $3.95 * (1 + 0.05798)

Expected dividend = $4.179

b).

Share price after flotation cost = $58.10

Net proceeds = Share price after flotation cost

Net proceeds = $58.10

c).

Share price = $66.78

Cost of retained earnings = (Expected dividend / Share price) + Growth rate

Cost of retained earnings = ($4.179 / $66.78) + 0.05798

Cost of retained earnings = 0.1206 or 12.06%

Therefore, the required return is 12.06%

d).

Net proceeds = $58.10

Cost of new common stock = (Expected dividend / Net proceeds from issue)+ Growth rate

Cost of new common stock = ($4.179 / $58.10 )+ 0.05798

Cost of new common stock = 0.1299 or 12.99%

Therefore, the cost of new common stock is 12.99%