Question

Mary's Bakery has common stock with a current price of $79 and paid dividends last year of $2.34. Common stock floatation costs are $12.65 per share and the growth rate on common stock is 7%. The firm's preferred stock sells for $109 with a $9.50 dividend per share and floatation costs of $6.25 per share.  

use four decimals places in the calculation.

Calculate the cost of preferred stock

Calculate the cost of common stock

Calculate the cost of retained earnings.

Answer 1

Compute the cost of preferred stock, using the equation as shown below:

Cost of preferred stock = Dividend/ (Selling price – Flotation cost)

                                      = $9.50/ ($109 - $6.25)

                                      = $9.50/ $102.75

                                      = 9.2457%

Hence, the cost of preferred stock is 9.2457%.

Compute the next expected dividend, using the equation as shown below:

Next dividend = Current dividend*(1 + Growth rate)

                        = $2.34*(1 + 0.07)

                        = $2.5038

Hence, the next expected dividend is $2.5038.

Compute the cost of common stock, using the equation as shown below:

Cost of common stock = {Next dividend/ (Current price – Flotation cost)} + Growth rate

                                     = {$2.5038/ ($79 – $12.65)} +7 %

                                     = {$2.5038/ $66.35} + 7%

                                     = 10.7736%

Hence, the cost of common stock is 10.7736%.

Compute the cost of retained earnings, using the equation as shown below:

Cost of retained earnings = {Next dividend/ Current price} + Growth rate

                                         = {$2.5038/ $79} +7 %

                                         = 3.1694% + 7%

                                         = 10.1694%

Hence, the cost of retained earnings is 10.1694%.