Question

Costly Corporation is considering using equity financing. Currently, the firm's stock is selling for $38.00 per share. The firm's dividend for next year is expected to be $4.10 with an annual growth rate of 7.0% thereafter indefinitely. If the firm issues new stock, the flotation costs would equal 15.0% of the stock's market value. The firm's marginal tax rate is 40%. What is the firm's cost of external equity?

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 = [ 4.10 / { 38*(1-15%) } ] + 7%

Re = 12.69% + 7%

Re = 19.69% .........Answer

Thanks