Gulf Electric Company (GEC) uses only debt and equity in its capital structure.
ID: 2698980 • Letter: G
Question
Gulf Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10% so long as it finances at its target capital structure, which calls for 55% debt and 45% common equity. Its last dividend was $2.20; its expected constant growth rate is 6%; its stock sells on the NYSE at a price of $35; and new stock would net the company $30 per share after flotation costs. GEC%u2019s tax rate is 40%, and it expects to have $100 million of retained earnings this year. What is GEC%u2019s cost of equity from newly issued stock? Answer 10.00% 13.33% 11.44% 12.29% 12.66% 13.77% Gulf Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10% so long as it finances at its target capital structure, which calls for 55% debt and 45% common equity. Its last dividend was $2.20; its expected constant growth rate is 6%; its stock sells on the NYSE at a price of $35; and new stock would net the company $30 per share after flotation costs. GEC%u2019s tax rate is 40%, and it expects to have $100 million of retained earnings this year. What is GEC%u2019s cost of equity from newly issued stock? Gulf Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10% so long as it finances at its target capital structure, which calls for 55% debt and 45% common equity. Its last dividend was $2.20; its expected constant growth rate is 6%; its stock sells on the NYSE at a price of $35; and new stock would net the company $30 per share after flotation costs. GEC%u2019s tax rate is 40%, and it expects to have $100 million of retained earnings this year. What is GEC%u2019s cost of equity from newly issued stock? 10.00% 13.33% 11.44% 12.29% 12.66% 13.77% 10.00% 13.33% 11.44% 12.29% 12.66% 13.77%Explanation / Answer
D / A = 55%; D0 = $2.20; g = 6%; P0 = $35; PN = $35; T = 40%
Retained earnings = $100M; BPRE = $100M / 0.45 = $222.22M
ks (component cost of retained earnings) = $2.33 / $35 + 6% = 12.66%
ke (component cost of external equity) = $2.33 / $30 + 6% = 13.77%
So, Answer is 13.77 %
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