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    EPS Growth Rate

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    Earnings per share in 2007 was $2.82, and in 2002 it was $1.65. The company's payout ratio is 30%, and the stock is currently valued at $41.50. Flotation costs for new equity will be 15%. Net income in 2008 is expected to be $15 million. The market-value weights of the firm's debt and equity are 40% and 60% respectively.

    a. Based on the five-year track record, what is EPS growth rate? What will the dividend be in 2008?

    b. Calculate the firm's cost of retained earnings, and the cost of new common equity.

    c. Calculate the breakpoint associated with retained earnings.

    d. If the after-tax cost of debt is 8%, what is the WACC with retained earnings? With new common equity?

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    Solution Preview

    a. Based on the five-year track record, what is EPS growth rate? What will the dividend be in 2008?

    First, we can find the five-year track record of EPS growth rate by using FV formula as follows: -

    FV = PV (1+R)N where PV is the present value
    R is the interest rate
    N is the period

    2.82 = 1.68(1+R)5
    2.82 = (1+R)5
    1.68

    1.68 = (1+R)5
    1+R = 1.681/5
    R = 11%

    2.82(1.11) = ...

    Solution Summary

    This solution is comprised of a detailed explanation and calculation to find EPS Growth rate, cost of retained earnings, cost of new common equity, breakpoint associated with retained earnings, and WACC.

    $2.49

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