Question

You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems related to the cost of capital. You are required to show the following 3 steps for each problem: (i) Describe and interpret the assumptions related to the problem. (ii) Apply the appropriate mathematical model to solve the problem. (iii) Calculate the correct solution to the problem. Round all answers to two decimal places.

Raven Co. expects to pay a dividend of $7.10 per share in one year. The current price of Raven common stock is $63.40 per share. Flotation costs are $5.00 per share when Raven issues new stock. What is the cost of internal common equity if the long-term growth in dividends is projected to be 4.75 percent indefinitely?

Answer 1

For Internal Common Equity, we don't use flotation costs in the calculation, as they are only considered for the new issues or external equity.

So,

r = [D1/P0] + g

= [$7.10 / $63.40] + 0.0475 = 0.1120 + 0.0475 = 0.1595, or 15.95%