Question

Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0%. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of equity from new common stock?a. 12.70%b. 13.37%c. 14.04%d. 14.74%e. 15.48%

Answer 1

Answer:

Cost of equity for new stock will be 12.8 %

So option (a) is correct option

Explanation:

We have given the common stock sells for $32.50

Earning per share = $3.50

Dividend pay out ratio = 60 %

So dividend will be = 3.50×0.6 = $2.1

Growth rate = 6 % = 0.06

Flotation rate = 5% = 0.05

We have to find the cost of new stock

We know that cost of equity from new stock will given by

$cost\ of\ equity=\frac{dividend}{price\ per\ share\times (1-flotation\ rate)}+growth\ rate$

$Cost\ of\ equity=\frac{2.1}{32.5 (1-0.05)}+0.06=0.1280=12.8%$