Ebook Problem Walk Through Cost of Equity Radon Homes' current EPS is $6.90. It was $4.17...

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 (EPS₁) = 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 (D₁) = EPS₁ * 50% = $7.63 * 50% = $3.82 per share

c) P = $40, D₁ = $3.82, growth rate (g) = 10.60%, r = cost of equity

Using Gordon's formula,

P = ((D₁ / (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 = (D₁/(P * (1 - f))) + g

where r = cost of equity, D₁ = 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%