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    Cost of Retained Earnings Using Dividend Discount Model

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    The Mountain Fresh Company had earnings per share (EPS) of $6.32 in 2007 and $11.48 at the end of 2012. The company pays out 30 percent of its earnings as dividends per share (DPS), and the company's stock price was $37.50 (at the end of 2012).

    (a) Calculate the growth rate in dividends (g) over the given period.
    (b) Calculate the expected dividend per share next year (what is D1 at the end of 2013, assuming the earnings and dividends of Mountain Fresh growth at a constant rate).
    (c) Based on the information given above, what is the cost of retained earnings common equity (rs) for Mountain Fresh Company?

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    Solution Preview

    Please see the attached file:
    The Mountain Fresh Company had earnings per share (EPS) of $6.32 in 2007 and $11.48 at the end of 2012. The company pays out 30 percent of its earnings as dividends per share (DPS), and the company's stock price was $37.50 (at the end of 2012).

    (a) Calculate the growth rate in dividends (g) over the given period.

    Payout ratio= 30%

    EPS Dividend
    2007 $6.32 $1.8960 =30.% x ...

    Solution Summary

    The solution calculates the cost of retained earnings, given the stock price, after calculating the growth rate in dividends. Dividend Discount model for stock price has been used for the calculations. Attached in Excel.

    $2.19