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 equity from new common stock?
A)12.70%
B)13.37%
C)14.04%
D)14.74%
E)15.48%

Question

Quizplus · Accepted Answer

First, calculate the expected dividend per share:
Expected dividend payout ratio = 65%
Expected earnings per share = $3.50
Expected dividend per share = $3.50 x 65% = $2.275

Next, calculate the cost of equity using the constant growth model:
Cost of equity = (Expected dividend per share / Current stock price) + Expected constant dividend growth rate
Cost of equity = ($2.275 / $32.50) + 6.0% = 13.37%

Finally, adjust for flotation costs:
Cost of equity from new common stock = Cost of equity / (1 - Flotation cost)
Flotation cost = 5%
Cost of equity from new common stock = 13.37% / (1 - 5%) = 14.04%

Therefore, the best choice is B, as it represents the cost of equity from new common stock, adjusted for flotation costs.