Gulf Electric Company
Gauteng Electric Company (GEC) uses only debt and equity in its capital structure.It can borrow unlimited amounts at an interest rate of 10 percent so long as it finances at its target capital structure, which calls for 55 percent debt and 45 percent ordinary equity.Its last dividend was R2.20; its expected constant growth rate is 6 percent; its shares sells on the JSE at a price of R35; and new shares would net the company R30 per share after flotation costs.GEC's tax rate is 40 percent, and it expects to have R100 million of retained earnings this year.GEC has two projects available: Project A has a cost of R200 million and a rate of return of 13 percent, while Project B has a cost of R125 million and a rate of return of 10 percent.All of the company's potential projects are equally risky.
-Refer to Gulf Electric Company.What is GEC's cost of equity from newly issued shares?

Question

Quizplus · Accepted Answer

The correct answer is A.The cost of equity from newly issued shares is calculated as follows:Ke = (D1 / P0) + gwhere:Ke = cost of equityD1 = last dividendP0 = current share priceg = expected constant growth rateIn this case, the last dividend is R2.20, the current share price is R35, and the expected constant growth rate is 6%. Therefore, the cost of equity from newly issued shares is:Ke = (2.20 / 35) + 0.06 = 13.77%

Gulf Electric Company Gauteng Electric Company (GEC) Uses Only Debt and Equity in and Equity