Question

The jackson company has just paid a dividend of $3.00 per share on its common stock, and it expects this dividend to grow by 10% per year, indefinitely. the firm has a beta of 2.00; the risk-free rate is 6%; and the market risk premium is 5%. the firm's investment bankers believe that new issues of common stock would have a flotation cost equal to 5% of the current market price. what will be jackson's cost of new common stock if it issues new stock in the marketplace today

Answer 1

Answer:

cost of new common stock= 16.3%

Explanation:

The value of a stock is the present value of its expected future dividend discounted at the cost of equity.

Cost of equity can be determined, using the capital pricing model (CAPM).

Cost of equity using CAPM:

Ke = Rf + β(Rm-Rf)

Rf= 6%, Rm-Rf =  5%, β= 2.00

E(r) =  6% + 2.00× (5%) = 16%

Current market price:

Market price = 3.00 × (1.1)/(0.16-0.1)

                     = $55

In incorporating the flotation cost and using the dividend valuation model,

the cost  new common stock will be:

Cost of new common stock:

= D0× (1+g)/Po × (1-F)  + g

Po- 55, g- 10%, F- 5%, Do- 3

= 3 × (1.1)/55× (1-0.05)    +  0.1

= 16.3%