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).
<em>Cost of equity using CAPM:</em>
Ke = Rf + β(Rm-Rf)
Rf= 6%, Rm-Rf = 5%, β= 2.00
E(r) = 6% + 2.00× (5%) = 16%
<em>Current market price:</em>
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:
<em>Cost of new common stock:</em>
= 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%
