2. The common stock for the bestsold corporation sells for $63, If a new issue i

Question

2. The common stock for the bestsold corporation sells for $63, If a new issue is sold the flotation costs are estimated to be 11%. The company pays 60% of its earnings in dividends and a $4.20 dividend was recently paid. Earnings per share 6 years ago were $5. Earnings are expected to grow at the same annual rate in the future as during the past 6 years. The firms marginal tax rate is 34%. Calculate the cost of (a) internal common equity and (b) external common equity. a. % to two decimal b. % to two decimal

Explanation / Answer

Current Earning per Share = Dividend per share/Payout ratio

Current Earning per Share = 4.2/60%

Current Earning per Share = $ 7

Growth Rate = (Current Earning per Share /Earnings per share 6 years ago)^(1/5) - 1

Growth Rate =(7/5)^(1/5) - 1

Growth Rate = 6.96%

(a) internal common equity

Internal common equity = Expected Dividend/Current Price + Growth Rate

Internal common equity = (4.20*(1+6.96%))/63 + 6.96%

Internal common equity = 14.09%

(b) external common equity

External common equity = Expected Dividend/(Current PriceLess Flotation Cost) + Growth Rate

External common equity = (4.20*(1+6.96%))/(63-11%*63) + 6.96%

External common equity = 14.97%

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