The Mobil Appliance Company’s earnings, dividends, and stock price are expected

Question

The Mobil Appliance Company’s earnings, dividends, and stock price are expected to grow at an
annual rate of 12%. Mobil’s common stock is currently traded at $18 per share. Mobil’s last cash div-
idend was $1.00, and its expected cash dividend for the end of this year is $1.12. Suppose that Mobil
wants to raise capital to finance a new project by issuing new common stock. With the new project, the
cash dividend is expected to be $1.10 at the end of the current year, and its growth rate is 10%. The
stock now sells for $18, but new common stock can be sold to net Mobil $15 per share.

What is Mobil’s cost of new common stock (ke)? Please show your work.

Explanation / Answer

Growth rate is 12%

Current price is 18$

Divedent this year is 1.12$

Now for new issue we have.

Divedend at end of 1st year is 1.1$

Growth rate 10%

New stock price is 15$

As per divedend discount model ee have D1/(ke - growth)

So ee have 15 = 1.1/(ke - 0.1)

Ke is 17.33% for new equity shares.

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