Question

# Business has been good for Keystone Control Systems, as indicated by the ten-year growth in earnings...

Business has been good for Keystone Control Systems, as indicated by the ten-year growth in earnings per share. The earnings have grown from \$1.00 to \$3.84.

a. Determine the compound annual rate of growth in earnings (n = 10)

b. Based on the growth rate determined in part a, project earnings for next year (E1). (Do not round intermediate calculations. Round your answer to 2 decimal places.)
c. Assume the dividend payout ratio is 50 percent. Compute D1. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
d. The current price of the stock is \$18. Using the growth rate (g) from part a and (D1) from part c, compute Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
e. If the flotation cost is \$3.00, compute the cost of new common stock (Kn) using growth rate (g) from part a and dividend (D1) from part c. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

a)
PV = 1
FV = 3.84
Nper = 10

Growth rate can be calculated by using the following excel formula:
=RATE(nper,pmt,pv,fv)
=RATE(10,0,-1,3.84)
= 14.40%

Growth rate = 14.40%

b)
Next year earnings = \$3.84 * (1 + 14.40%) = \$4.39%

Next year earnings (E1)= \$4.39

c)
D1 = E1 * Payout ratio
= \$4.39 * 50%
= \$2.20

D1 = \$2.20

d)
Ke = (D1 / P0) + g
= (\$2.20 / \$18) + 0.1440
= 0.1220 + 0.1440
= 26.60%

Ke = 26.60%

e)
Cost of new common stock = (D1 / (P0 - F) + g
= (\$2.20 / (\$18 - \$3)) + 0.1440
= (\$2.20 / \$15) + 0.1440
= 0.1464 + 0.1440
= 29.05%

Cost of new common stock = 29.05%

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