Question

In: Finance

A company’s Balance Sheet (in millions) Assets                                  &nbs

A company’s Balance Sheet (in millions)

Assets                                                             Liabilities & Equity

Current                        $  80              

Net Fixed                    $120                            Bonds ($1000 Par)                  130

                                                                        Preferred stocks ($100 Par)   40

Total                           $200                            Common Stock ($1 par)         30

                                                                        Total                                       $200

The company's bonds have 10 years to mature, pay 10% coupon rate semi-annually and comparable bonds' YTM is 14%.

The company’s applicable tax rate is 40%.

The market price of common stock is $10.50 per share.

The common stock is constantly growing at a rate of 6%. The same growth rate is expected to continue for long time in the future. The most recent dividend on the common stock was $1.15.

The flotation cost for new common stocks is 10%.

The market value of the preferred stock is $45 and it pays quarterly dividend of $1.25.

The flotation cost on issuing new preferred stock is 7%

What is the cost of issuing new common stock?

18.90%

16.84%

19.52%

14.76%

11.84%

Solutions

Expert Solution

Information provided:

Current dividend= $1.15

Current stock price= $10.50

Dividend growth rate= 6%

Flotation cost= 10%

Cost of new equity= D1/ Po*(1 – f) + g

Where:

D1= Next year’s dividend

Po= current stock price

f= flotation cost

g= growth rate

Cost of new common stock= $1.15*(1 + 0.06)/ $10.50*(1 – 0.10) + 0.06

                                                    = $1.2190/ $9.45 + 0.06

                                                    = 0.1290 + 0.06

                                                    = 0.1890*100

                                                    = 18.90%.

Hence, the answer is option a.

In case of any query, kindly comment on the solution.

jeff jeffy answered 6 months ago
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