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26 July, 12:16

Oval Inc. just paid a dividend equal to $1.50 per share on its common stock, and it expects this dividend to grow by 4 percent per year indefinitely. The firm plans to issue common stock, which has a $16 per share market price, to raise funds to support operations. Oval's investment bankers estimate that the flotation costs for new issues of common stock will be equal to 8 percent of the issue (market) price. What is Oval's cost of new common equity, re? a. 13.38%b. 10.60%c. 8.76%d. 18.55%e. 14.60%

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  1. 26 July, 12:31
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    e. 14.60%

    Explanation:

    The computation of Oval's cost of new common equity is shown below:-

    Price of stock = Estimated dividends for next period : (Required rate of return - Growth rate)

    Dividend = $1.50 * (1 + 4%)

    = $1.56

    Price of stock would be the price net of flotation cost

    = $16 * (1 - 8%)

    = $14.72

    Required rate of return

    = (1.56 : 14.72) + 0.04

    = 14.60%
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