(cost of equity) The common stock for the Bestsold Corporation sells for $58. If

Question

(cost of equity) The common stock for the Bestsold Corporation sells for $58. If a new issue is sold, the flotation costs are estimated to be 8 percent. The company pays 50 percent of its earnings in dividends, and a $4 dividend was recently paid. Earnings per share 5 years ago were $5. Earnings are expected to continue to grow at the same annual rate in the future as during the past 5 years. The firm's marginal tax rate is 34 percent. Calculate the cost of (a) internal common equity and (b) external common equity.

Explanation / Answer

Hi!This is a similar question with different numericals to the one I am posting along with answer .It would serve you more better if you practice on your own :) Q: The common stock for Grapevine Plumbing Company currently sells for $40 per share. If a new issue is sold the flotation cost is estimated to be $7 per share. The company had earnings of $2.00 per share four years ago. Next year the company expects to have earnings of $3.22 per share. The company maintains a constant dividend payout ratio of 40 percent. Earnings per share are anticipated to grow at the same rate in the future. The firm's marginal tax rate is 30 percent. Calculate the cost of internal equity capital and external equity capital. Ans: P0 = $40 Floatation cost = $7 D1 = $3.22 compound annual growth rate = [Ending value/beginning value]^(1/no.of periods)-1 CAGR =( $3.22 - $2)^1/5 -1 Compound annual growth rate = 9.99 or 10% Cost of internal equity =r P0 = Div1/r-g $40 = $3.22/r - .10 r = 18.05% Cost of internal equity = 18.05% Cost of external equity The cost of external equity is just like the formula for internal equity (retained earnings) except that you base it on the net proceeds after flotation costs rather than the market value of the stock. P0=DIv1/r-g $40 - $7 =$3.22/r-.10 r=19.75%

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.