1. (35 points) You are a new employee of the Scannell Poultry Processing Company and as a part of your training, you are asked to determine the cost of equity capital (retained earnings) for the firm. The annual earnings per share (EPS) are shown below and you use the annual compound growth rate of EPS to estimate the future growth rate. The latest (2022) dividend per share is (D₀ = 4.70), the stock price is $100.

EPS

2017 $7.84

2018 8.32

2019 8.83

2020 9.37

2021 9.94

2022 10.55

Also, you observe that the current 10-year U.S. treasury rate is 2.90 percent and according to Pablo Fernandez, et.al. survey, the average US stock market risk premium (stock market return less yield on 10-year US Treasuries) used by investors is 5.5 percent. The beta for Scannell is 1.492. To estimate the firms grow rate, use the annual compound growth rate (g) for EPS for the 5-year period from 2017-2022.

1. What is your estimated cost of retained earnings? Use both the DCF and the CAPM models in your estimates.

DCF Model

r_s = D₁/P₀ + g

CAPM Model

r_s = r_rf + [5.5%]

2. Given a transaction (flotation) costs of 4% for newly issued common stock, what is the percentage cost of new-issue common stock for Scannell?

3. Explain why retained earnings has a cost?