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 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 15.8%.

Allison Engines Corporation Has Established a Target Capital Structure of 40