1.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:
YearDividend
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).
First step:Divide the last dividend by the first dividend:
Second step: compute the Nth root of the above result, where N = the number of years of the growth period. In this question, compute the 5th root of 1.46
Third step: Subtract 1 from the second step outcome, and multiply the result by 100 to get the growth rate as a percentage:
(1.07863 - 1)100 = 7.863%
(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).