Question

The gift shop is a large online franchise. Their stock is currently trading at $30 and...

The gift shop is a large online franchise. Their stock is currently trading at $30 and paid a $3 dividend today. They expect dividends to grow at least 2.5% per year. If they have to issue new stock, they have to pay a floatation cost of $2 per share.

1. find the value of the internal cost of equity

2. find the value of external cost of equity

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Answer #1

Div1 = $3 * (1 + 2.5%) = $3.075

1) cost of internal equity

r - 0.025 = 3.075/30

r = 12.75%

2) cost of external equity

Price needs to be adjusted for floatation cost = $30 - $2 = $28

r - 0.025 = 3.075/28

r = 13.48%

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