Expected cash dividends are $3.00, the dividend yield is 4%, flotation costs are 4% of price, and the growth rate is 3%. Compute the approximate cost of new common stock.

Question

Quizplus · Accepted Answer

The cost of new common stock can be calculated using the formula: $ \text{Cost of new common stock} = \frac{\text{Expected dividend}}{\text{Price} - \text{Flotation cost}} + \text{Growth rate} $. Given that the dividend yield is 4%, we can find the price by rearranging the dividend yield formula: $ \text{Dividend yield} = \frac{\text{Expected dividend}}{\text{Price}} $, which gives us $ \text{Price} = \frac{\text{Expected dividend}}{\text{Dividend yield}} = \frac{3.00}{0.04} = 75 $. The flotation cost is 4% of price, which is $ 0.04 \times 75 = 3 $. Thus, the cost of new common stock is $ \frac{3}{75 - 3} + 0.03 = \frac{3}{72} + 0.03 = 0.04167 + 0.03 = 0.07167 $ or approximately 7.2%.

Expected Cash Dividends Are $3