Johnson Production Company paid a dividend yesterday of $3.50 per share. The div
ID: 2635830 • Letter: J
Question
Johnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of Johnson's common stock today is $40 per share. If Johnson decides to issue new common stock, flotation costs will equal $4.00 per share. Johnson's marginal tax rate is 35%. Based on the above information, what is the cost (r) of new common stock? (%)
In general, what is the least expensive source of financing? Debt, new common stock, preferred stock or retained earnings?
Explanation / Answer
Cost of equity by constant growth model is:- D1/(P0-f)+g,
where, D1=Dividend at the end of 1 year or say (D0+g)
P0= Price of stock today
f=Floataion cost of new stock.
g= growth rate.
Therefore, Cost of equity(KE) = [3.5+10%/(40-4)] +10%
= 20.694%(Final answe)
In general Debt is cheapest source of finance.
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