Use the dividend growth model to determine the required rate of return for equit

Question

Use the dividend growth model to determine the required rate of return for equity. Your firm intends to issue new common stock. Your investment bankers have determined that the stock should be offered at a price of $45.00 per share and that you should anticipate paying a dividend of $1.50 in one year. If you anticipate a constant growth in dividends of 3.50% per year and the investment banking firm will take 7.00% per share as flotation costs, what is the required rate of return for this issue of new common stock?

Explanation / Answer

Offered price =45

But due to folation cost you would get 7% less

Therfore firm will get =45*(1-.07) =41.85

Return on equity woul be give by

r= D1/ P + g

D1= 1.5

P = current stock price after flotation cost

g= growth rate

=1.5/41.85 + 3.5% =7.08%

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