Montreal Trustco expects to pay a dividend of $5 next year.Dividends are expected to grow at 3% for the foreseeable future and the market requires a rate of return of 7% on its stock.Montreal Trustco can issue new stock at $125 per share with after-tax flotation costs of $20 per share.The cost of issuing new equity to Montreal Trustco is:

Question

Quizplus · Accepted Answer

The cost of issuing new equity can be calculated using the following formula:

Cost of New Equity = (Dividend / Net Proceeds) + Growth Rate
 
where,
Dividend = expected dividend per share for the next year
Net Proceeds = price per share - after-tax flotation cost per share
Growth Rate = expected growth rate of dividends

So, in this case, the cost of issuing new equity would be:

Cost of New Equity = ($5 / ($125 - $20)) + 3% = 7.76%

Therefore, the best choice for the cost of issuing new equity is option C, which is 7.76%.

Montreal Trustco Expects to Pay a Dividend of $5 Next