Question

Madden Inc.'s common stock currently sells for $15.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected growth rate is 6%. 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 retained earnings? A) 78% B) 1.12% C).67% D) 1.45% E) 89%

Answer 1

Correct answer: B) 1.12%

Expected earning per share (E) = $2.75

Dividend payout ratio = 70%

Expected dividend per share (D1) = 2.75*0.7 = $1.925

Current price of Stock (P) = $15

Growth rate = 6%

Cost of retained earning on existing share = r

T= +9

1.925 -+ 0.06

r = 0.188333333333333

r = 18.83%

Flotation cost on new issue(F) = 8%

Cost of retained earning on new issue = i

D1 * P*(1 - F) +9

1.925 **15*(1-0.08)

i = 0.199492753623188

i=19.95%

Cost of retained earning on new issue exceed cost of retained earning on existing by:

A. - -

= 0.1995-1883

= 0.0112

= 1.12%

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