Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity.The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings.The current market price of the firm's stock is P0 = $28; its last dividend was D0 = $2.20, and its expected dividend growth rate is 6 percent.Allison can issue new common stock at a 15 percent flotation cost.What
Will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital?
A)15.8%
B)13.9%
C)7.9%
D)14.3%
E)9.7%

Question

Quizplus · Accepted Answer

The correct answer is A because the marginal cost of equity capital is the cost of raising new equity capital, which includes the flotation cost. In this case, the flotation cost is 15%, so the marginal cost of equity capital is 15.8%.

Allison Engines Corporation Has Established a Target Capital Structure of 40