Question

Radon Homes' current EPS is $7.30. It was $4.28 5 years ago. The company pays out 50% of its earnings as dividends, and the stock sells for $34. a) Calculate the historical growth rate in earnings. (Hint: This is a 5-year growth period.) Do not round intermediate calculations. Round your answer to two decimal places. ____% b) Calculate the next expected dividend per share, D1. (Hint: D0 = 0.50($7.30) = $3.65.) Assume that the past growth rate will continue. Do not round intermediate calculations. Round your answer to the nearest cent _____ %. c)$ What is Radon's cost of equity, rs? Do not round intermediate calculations. Round your answer to two decimal places. _____%

Answer 1

Answer a.

Growth Rate = (Current EPS / EPS 5 years ago)^(1/5) - 1
Growth Rate = ($7.30 / $4.28)^(1/5) - 1
Growth Rate = 1.7056075^(1/5) - 1
Growth Rate = 1.1127 - 1
Growth Rate = 0.1127 or 11.27%

Answer b.

Current Dividend = Current EPS * Payout Ratio
Current Dividend = $7.30 * 0.50
Current Dividend = $3.65

Expected Dividend = Current Dividend * (1 + Growth Rate)
Expected Dividend = $3.65 * 1.1127
Expected Dividend = $4.06

Answer c.

Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $4.06 / $34.00 + 0.1127
Cost of Equity = 0.1194 + 0.1127
Cost of Equity = 0.2321 or 23.21%