Question

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
(*E*_{1}). **(Do not round intermediate
calculations. Round your answer to 2 decimal
places.)**

**c.** Assume the dividend payout ratio is 50 percent.
Compute *D*_{1}. **(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
(*D*_{1}) from part *c*, compute
*K*_{e}. **(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 (*K _{n}*) using growth rate
(

Answer #1

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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ANSWER**

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