Question

The Following information pertains to the common equity of Funtastic Furniture Company:

Current Selling Price $68

Constant Growth Rate 8%

Most recent paid dividend $3.50

Flotation Costs 10%

Marginal Tax Rate 40%

A. What is the company's cost of retained earning?

B. What is the company's cost of new common stock?

Answer 1

Given,

Current selling price = $68

Constant growth rate (g) = 8% or 0.08

Dividend paid = $3.50

Flotation costs (f) = 10% or 0.10

Solution :-

Expected dividend = Dividend paid x (1 + g)

= $3.50 x (1 + 0.08)

= $3.50 x 1.08 = $3.78

(A)

Cost of retained earnings = (expected dividend/current selling price) + g

= ($3.78/$68) + 0.08

= 0.0556 + 0.08 = 0.1356 or 13.56%

(B)

Cost of new common stock = [expected dividend/{current selling price x (1 - f)}] + g

= [$3.78/{$68 x (1 - 0.10}] + 0.08

= [$3.78/{$68 x 0.90}] + 0.08

= [$3.78/$61.20] + 0.08

= 0.0618 + 0.08 = 0.1418 or 14.18%