Temple Company's common stock dividends have grown over the past 5-year period from $0.60 per share to $0.89 (today). Assume that Temple's dividends are expected to grow at this rate for the foreseeable future. Temple's stock is currently selling for $12 per share. New common stock can be sold to net the company $11 per share. Determine the costs of internal and external equity to Temple.

Question

Quizplus · Accepted Answer

Using the dividend growth model, we can calculate the cost of internal equity as follows:
Cost of Internal Equity (Re) = (Next year's dividend / Current market price) + Dividend growth rate
Cost of Internal Equity = (0.89 / 12) + 0.0742 = 0.1517 or 15.17%
Using the net proceeds from the sale of new common stock, we can calculate the cost of external equity as follows:
Cost of External Equity (Re) = (Next year's dividend / Net proceeds from sale of new common stock) + Dividend growth rate
Cost of External Equity = (0.89 / 11) + 0.0742 = 0.1687 or 16.87%
Therefore, the costs of internal and external equity to Temple are 15.17% and 16.87%, respectively. The closest option is C (16.2%, 16.9%).

Temple Company's Common Stock Dividends Have Grown Over the Past