Question

Costly Corporation is considering using equity financing. Currently, the firm's stock is selling for $31.00 per share. The firm's dividend for next year is expected to be $4.30 with an annual growth rate of 6.0% thereafter indefinitely. If the firm issues new stock, the flotation costs would equal 13.0% of the stock's market value. The firm's marginal tax rate is 40%. What is the firm's cost of external equity?

20.69%

19.87%

20.70%

22.90%

21.94%

Answer 1

Cost of Equity, Re= [ D1 / { Price*(1 - F) } ] + g

Where,
D1 is dividend in next period
Price is the issue price of a share of stock
F is the ratio of flotation cost to the issue price
g is the dividend growth rate

Substituting the values we have

Re = [ 4.30 / { 31*(1-13%) } ] + 6%

Re = 15.94% + 6%

Re = 21.94% .........Answer