Weaver Chocolate Co. expects to earn $3.50 per share during the current year, it

Question

Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected
dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its
common stock currently sells for $32.50 per share. New stock can be sold to the public at the
current price, but a flotation cost of 5% would be incurred. What would be the cost of retained
earnings common equity (rs) for Weaver Chocolate Co.? What would be the cost of equity from
new common stock (re)?



Cost of Retained Earnings Common Equity (rs) = ____________________.



Cost of Newly Issued Common Stock (re) = ____________________.

Explanation / Answer

Expected EPS = $3.50 per share
Expected dividend per share, D1 = $3.50 x 65% = $2.275
Proceeds from the new stock sale = $32.50 – ($32.50 x 5%) = $32.50 – $1.625 = $30.875

Cost of equity from new common stock = (D1/Proceeds) + g
=($2.275/$30.875) + .06
= 0.07368 + .06
= 0.13368 (or) 13.37%

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