Question

Eakins Inc.'s common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of common from retained earnings? 0.09% 0.19% 0.37% 0.56% 0.84%

Answer 1

Answer:

0.37%

Explanation:

Since the expected payout ratio and earning per share is given, so we compute the current dividend which is shown below:

= Earning per share × payout ratio

= $2.75 × 70%

= $1.925

Now the cost of retained earning would be

= Current year dividend ÷ price + Growth rate

=  $1.925 ÷ $45  + 0.06

= 10.28%

And, the cost of new stock would be

= Current year dividend ÷ price × (1 - flotation cost) + Growth rate

=  $1.925 ÷ $45 × (1 - 0.08)  + 0.06

= 10.65%

So, the exceed cost would be

= 10.65% - 10.28%

= 0.37%