J.Ross and Sons Inc.
J.Ross and Sons Inc.has a target capital structure that calls for 40 percent debt, 10 percent preference shares, and 50 percent ordinary equity.The firm's current after-tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate.The firm's preference shares currently sell for R90 a share and pays a dividend of R10 per share; however, the firm will net only R80 per share from the sale of new preference shares.Ross expects to retain R15,000 in earnings over the next year.Ross' ordinary shares currently sells for R40 per share, but the firm will net only R34 per share from the sale of new ordinary shares.The firm recently paid a dividend of R2 per share on its ordinary shares, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year.
-Refer to J.Ross and Sons Inc.What is the firm's cost of newly issued ordinary shares?

Question

Quizplus · Accepted Answer

The cost of newly issued ordinary shares can be calculated using the Gordon Growth Model: Cost of Equity = (D1 / P0) + g, where D1 is the expected dividend, P0 is the net price per share, and g is the growth rate. Here, D1 = 2 * (1 + 0.10) = 2.2, P0 = 34, and g = 0.10. Thus, Cost of Equity = (2.2 / 34) + 0.10 = 0.165 or 16.5%.