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A company expects to issue new stock at $29 a share with estimated flotation costs of...

A company expects to issue new stock at $29 a share with estimated flotation costs of 8 percent of the market price. The company currently pays a $2.25 cash dividend and has a 7 percent growth rate. What is the cost of new common stock?

12.77%

9.02%

15.30%

14.90%

16.02%

Solutions

Expert Solution

Compute the net proceeds from the stock, using the equation as shown below:

Net proceeds = Market price*(1 – Flotation cost)

                      = $29*(1 – 0.08)

                      = $26.68

Hence, the net proceeds is $26.68.

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

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

                      = $2.25*(1 + 0.07)

                        = $2.4075

Hence, the next expected dividend is $2.4075.

Compute the cost of equity, using the equation as shown below:

Cost of equity = (Next expected dividend/ Net proceeds) + Growth rate

                        = ($2.4075/ $26.68) + 7%

                        = 9.02% + 7%

                        = 16.02%

Hence, the cost of equity is 16.02%.

jeff jeffy answered 1 year ago
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