Sentry Manufacturing paid a dividend yesterday of $5 per share (D0 = $5).The dividend is expected to grow at a constant rate of 8% per year.The price of Sentry Manufacturing's stock today is $29 per share.If Sentry Manufacturing decides to issue new common stock,flotation costs will equal $2.50 per share.Sentry Manufacturing's marginal tax rate is 35%.Based on the above information,the cost of new common stock is
A) 28.38%.
B) 24.12%.
C) 26.62%.
D) 31.40%.

Question

Quizplus · Accepted Answer

The cost of new common stock is 28.38%.The cost of new common stock is calculated as follows:Cost of new common stock = (D1 / (P0 - F)) + gwhere:D1 = expected dividend in one yearP0 = current stock priceF = flotation costsg = expected constant growth rateIn this case, we have:D1 = $5 * (1 + 0.08) = $5.40P0 = $29F = $2.50g = 0.08Therefore, the cost of new common stock is:Cost of new common stock = ($5.40 / ($29 - $2.50)) + 0.08 = 28.38%

Sentry Manufacturing Paid a Dividend Yesterday of $5 Per Share