Marigold Inc.'s common stock currently sells for $40 per share, but the firm will net only $34 per share if it issues new common stock. The firm recently paid a dividend equal to $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. What is Marigold's cost of new common equity?

Question

Quizplus · Accepted Answer

The cost of new common equity can be calculated using the Gordon Growth Model: Cost of Equity = (D1 / P0) + g, where D1 is the expected dividend next year, P0 is the net price per share, and g is the growth rate. D1 = $2 * (1 + 0.10) = $2.20, P0 = $34, g = 0.10. Cost of Equity = ($2.20 / $34) + 0.10 = 0.0647 + 0.10 = 0.1647 or 16.47%.