A firm has common stock with a market price of $100 per share and an expected dividend of $5.61 per share at the end of the coming year. A new issue of stock is expected to be sold for $98, with $2 per share representing the underpricing necessary in the competitive capital market. Flotation costs are expected to total $1 per share. The dividends paid on the outstanding stock over the past five years are as follows:

YearDividend

1$ 4.00

24.28

34.58

44.90

55.24

The cost of this new issue of common stock is

A) 5.8 percent.

B) 7.7 percent.

C) 10.8 percent.

D) 12.8 percent.

Question

Savanna

Business

21 October, 04:35

A firm has common stock with a market price of $100 per share and an expected dividend of $5.61 per share at the end of the coming year. A new issue of stock is expected to be sold for $98, with $2 per share representing the underpricing necessary in the competitive capital market. Flotation costs are expected to total $1 per share. The dividends paid on the outstanding stock over the past five years are as follows:

YearDividend

1$ 4.00

24.28

34.58

44.90

55.24

The cost of this new issue of common stock is

A) 5.8 percent.

B) 7.7 percent.

C) 10.8 percent.

D) 12.8 percent.

+5

Answers (1)

Know the Answer?

Moses Sellers · Answer 1

Option (D) is correct.

Explanation:

According to Gordong growth model

D1 = $ 5.61, p0 = $ 98

g = (5.61 - 5.24) : 5.24

= 7.06%

Cost of Equity = D1 : P0 + g

= (5.61 : 98) + 7.06

= (0.0572 * 100) + 7.06

= 5.72 + 7.06

= 12.78

= 12.8 %