Question

Expected cash dividends are $4.00, the dividend yield is 8%, flotation costs are 6% of price, and the growth rate is 5%. Compute the approximate cost of new common stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Explanation:

$\text { Dividend, } \mathrm{D}= 4 \\\text { Dividend yield rate }=\mathrm{D} / \text { Current price }=8 % \\\text { Current price }, \mathrm{P} 0=\mathrm{D} / 8 \%=\ 4 / 8 \%= 50$

$\text { Flotation cost, } \mathrm{F}=8 \% \text { of current price }=\ 50 * 8 \%=\ 4 \\ \text { Growth rate,g }=4 % \\ \text { Cost of new common stock, } \mathrm{Ke}=[\mathrm{D} 1 /(\mathrm{P} 0-\mathrm{F})]+\mathrm{g} \\ =[\ 4 /(\ 50-\ 4)]+4 \% \\ =0.086956522+0.04 \\ =0.126956522=12.7 \% \text {(Rounded) }$

12.7%