Keystone Corporation will issue new common stock to finance an expansion.The existing common stock just paid a $1.50 dividend,and dividends are expected to grow at a constant rate 8% indefinitely.The stock sells for $45,and flotation expenses of 5% of the selling price will be incurred on new shares.What is the cost of new common stock be for Keystone Corp.?
A) 11.33%
B) 11.51%
C) 11.60%
D) 11.79%
E) 12.53%

Question

Quizplus · Accepted Answer

The cost of new common stock can be calculated using the dividend discount model (DDM) adjusted for flotation costs. The formula for the cost of new equity (re) is: re = (D1 / P0(1 - F)) + g, where D1 is the dividend next year, P0 is the current price, F is the flotation cost as a decimal, and g is the growth rate. D1 = $1.50 * (1 + 0.08) = $1.62, P0 = $45, F = 0.05, and g = 0.08. Plugging these into the formula gives re = ($1.62 / ($45 * (1 - 0.05))) + 0.08 = 11.79%.

Keystone Corporation Will Issue New Common Stock to Finance an Expansion.The