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Wellstock Corp. will issue new common stock. The company’s existing common stock is selling for $26.50 per share and offered $2.25 per share in dividends at the end of last year. Dividends are expected to grow at an annual rate of 6% indefinitely. New issues of common stock will incur 8% of the current market price. What is the cost of the company’s new commonstock?

Sagot :

Answer:

(2.25 * 1.06) / [26.5 * (1 - 8%)] + 6% = .15782608 now multiply by 100 to get %

15.78%  

Explanation:

The following formula is used to calculate cost of new equity:

Cost of New Equity = D1 / [ Po * (1 - F)] + g

Where,

D1 is dividend in next period...current dividend * (1 + dividend growth rate)

Po is the issue price of a share of stock

F is the ratio of flotation cost to the issue price

g is the dividend growth rate.

The growth rate referred above is the sustainable growth rate which equals the product of retention ratio and return on equity (ROE).

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