Question

Messman Manufacturing will issue common stock to the public for $50. The expected dividend and the growth in dividends are $3.50 per share and 5%, respectively. If the flotation cost is 10% of the issue's gross proceeds, what is the cost of external equity, re

Answer 1

Answer:

cost of equity  = 13.2%

Explanation:

According to the  dividend valuation, the value of a stock is the present value of expected future dividends discounted at the required rate of return.

The model can me modified to determined the cost of equity having flotation cost as follows:

Cost of equity = D(1+r )/P(1-f) + g

d- dividend, p- price of stock , f - flotation cost , - g- growth rate

D- 3.50 , p - 3.50, f- 10% g- 5%

Applying this to the question;

cost of equity - 3.50× (1.05)/3.50×(1-0.1) + 0.05

                     =  0.1316 × 100

cost of equity  = 13.2%