Question

Costly Corporation is considering using equity financing. Currently, the firm's stock is selling for $29.00 per share. The firm's dividend for next year is expected to be $5.30 with an annual growth rate of 5.0% thereafter indefinitely. If the firm issues new stock, the flotation costs would equal 15.0% of the stock's market value. The firm's marginal tax rate is 40%. What is the firm's cost of internal equity?

Answer 1

Firm's cost of Internal Equity

Firm's cost of Internal Equity is calculated by using the following formula

Firm's cost of Internal Equity = (D1 / P0) + g

Where, Dividend in Next Year (D1) = $5.30 per share

Current selling price of the share (P0) = $29.00 per share

Dividend Growth Rate (g) = 5%

Therefore, the Firm's cost of Internal Equity = (D1 / P0) + g

= ($5.30 / $29.00) + 0.05

= 0.1828 + 0.05

= 0.2328

= 23.28%

“Hence, the Firm's cost of Internal Equity = 23.28%”