Question

wants to know their cost of capital. The common stock is currently sold at par value, for $35, and offers a dividend by the end of this year of 6%. The amount of the dividend has been increasing consistently and five years ago, the dividend was $1.675. To issue new shares, the flotation costs add up 2.2% and there is an underpricing of 1.5%. The marginal tax applied to the company is 34%

Answer 1

Cost of Capital = 13.05%

Note:

1. Dividend from 5 years ago is assumed to grow at 6% per annum

2. Floatation costs and underpricing percentage is reduced from current price of the stock to arrive at the issue price of the share

3. Under Dividend Growth Model, Price of share = Dividend next year / (cost of capital - growth rate).

The above equation is changed to estimate the cost of capital as:

Cost of capital = (Dividend next year / Price of share) + growth rate