Question

Compute K_e and K_n under the following circumstances:

c. E₁ (earnings at the end of period one) = $6, payout ratio equals 30 percent, P₀ = $42, g = 10.0%, F = $3.50. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

d. D₀ (dividend at the beginning of the first period) = $4, growth rate for dividends and earnings (g) = 5%, P₀ = $68, F = $5. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

Ans:- (c) Cost of equity (ke) = D1 / P0 + g, where D1 is the next dividend to be paid, P0 is the current stock Price and g is the growth rate.

Cost to issue new common stock (kn) = D1 / [ P0 - F ] + g, where F is the Floation costs.

D1 in this case will be calculated by  E1 * Payout ratio = $6*0.30 = $1.80.

ke = $1.80 / $42 + 10% = 14.29%

kn = $1.80 / [ $42 - $3.50 ] + 10% = 14.68%.

Ans:-(d) D1, in this case, will be calculated by D0*(1+g), where D0 is the last dividend paid and g is the growth rate

D1=$4*(1+5%) = $4.20

Cost of equity (ke) = $4.20 / $68 + 5% = 11.28%

Cost to issue new common stock = $4.20 / [ $68 - $5 ] + 5% = 11.67%.

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