## Answers

a) The current EPS = $6.90, EPS 5 years ago = $4.17, n = 5 years

Thus, the growth in earnings can be calculated by using Compounded Annual Growth Rate (CAGR) formula.

CAGR = ((Ending EPS/Beginning EPS)^{(1/n)}) - 1 = (($6.90/$4.17)^{1/(5)}) - 1 = ((1.654676259)^{1/5}) - 1 = 1.105968117 - 1 = 0.105968117 = 10.60%

b) Future EPS (EPS_{1}) = Current EPS * (1 + Growth rate) = $6.90 * (1+ 10.60%) = $6.90 * (1.1060) = $7.63

Dividends are paid as 50% of earnings. Thus, next year's dividend (D_{1}) = EPS_{1} * 50% = $7.63 * 50% = $3.82 per share

c) P = $40, D_{1} = $3.82, growth rate (g) = 10.60%, r = cost of equity

Using Gordon's formula,

P = ((D_{1} / (r - g))

40 = ((3.82 / (r - 0.1060))

r - 0.1060 = 3.82/40

r - 0.1060 = 0.0953925

r = 0.0953925 + 0.1060 = 0.2013925

r = 20.14%

**Messman Manufacturing**

Gordon's growth formula along with flotation costs is as follows

r = (D_{1}/(P * (1 - f))) + g

where r = cost of equity, D_{1} = expected dividend ($3.00), P = stock price ($35), f = flotation costs (13%), g = growth rate (6%)

r = (3 / (35 * (1 - 13%))) + 6% = (3 / (35 * (0.87))) + 6%

r = (3 / 30.45) + 0.06 = 0.098522 + 0.06

r = 0.158522 = 15.85%

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