Bouchard Company\'s stock sells for $20 per share, its last dividend (D0) was $1

Question

Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 5 percent, and the company would incur a flotation cost of 7 percent if it sold new common stock. Retained earnings for the coming year are expected to be $1,000,000, and the common equity ratio is 55 percent. If Bouchard has a capital budget of $2,000,000, what component cost of common equity will be built into the WACC for the last dollar of capital the company raises? The answer is 10.65% but an explanation would be really helpful.

Explanation / Answer

Answer: Net Proceeds=Selling price-Flotation cost

=$20-$20*7%

=$18.6 per share

D1=D0(1+g)

=1(1+5%)

=$1.05

Ke=[D1/NP]+g

=[$1.05/$18.6]+0.05

=0.1065 or 10.65%

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