Question

ADF stock paid a dividend yesterday of $3 per share. The dividend is expected to grow at a constant rate of 5% per year. The price of ADF's common stock today is $40 per share. If ADF decides to issue new common stock, flotation costs will equal 3% of the market price. ADF's marginal tax rate is 21%. Based on the above information, the cost of equity is:

A) 20.93%

B) 15.27%

C) 11.33%

D) 13.12%

Answer 1

Answer is 13.12%

Last Dividend, D0 = $3.00
Growth Rate, g = 5.00%
Current Price, P0 = $40.00
Flotation Cost, F = 3.00%

Expected Dividend, D1 = D0 * (1 + g)
Expected Dividend, D1 = $3.00 * 1.05
Expected Dividend, D1 = $3.15

Cost of Equity = D1 / [P0 * (1 - F)] + g
Cost of Equity = $3.15 / [$40.00 * (1 - 0.03)] +0.05
Cost of Equity = $3.15 / $38.80 + 0.05
Cost of Equity = 0.0812 + 0.05
Cost of Equity = 0.1312 or 13.12%