QUESTION 25 As the winner of a contest, you are now CFO for the day for Maguire

Question

QUESTION 25

As the winner of a contest, you are now CFO for the day for Maguire Inc. and your day’s job involves raising capital for expansion. Maguire’s common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of common from retained earnings?

0.09%

0.19%

0.37%

0.56%

0.84%

0.09%

0.19%

0.37%

0.56%

0.84%

Explanation / Answer

First of all,we have to calculate Ke

Ke can be obtained by using dividend valuation formula

Ke = D1/P0 + g

D1 = (2.75*70%) =1.925

Ke = 1.925/45 + 0.06

=0.1028 or 10.28%(rounded off to nearest cents)

Ke can be taken as cost of reatined earnings also.

Since flotation costs is 8%,the net proceeds will be 92% of current stock price i.e 41.4

Cost of new stock = 1.925/41.04 + 0.06

=.1065 0r 10.65%

Excess cost of new stock =10.65% - 10.28% = 0.37%

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