Question

What is the cost of new equity assuming the firm's stock price is currently selling for $10 and will pay a dividend of $2 next year. The firm expects constant growth of 1.19% and floatation costs associated with the new equity issue of 20%. Write your answer as a decimal.

Answer 1

Information provided:

Next year’s dividend= $2

Current stock price= $10

Dividend growth rate= 1.19%

Flotation cost= 20%

Cost of new equity= D1/ Po*(1 – f) + g

Where:

D1= Next year’s dividend

Po= current stock price

f= flotation cost

g= growth rate

Ke= $2/ $10*(1 – 0.20) + 0.0119

     = $2/ $8 + 0.0119

     = 0.25 + 0.0119

     = 0.2619*100

     = 26.19%

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