Your company's stock sells for $50 per share,its last dividend (D₀)was $2.00,its growth rate is a constant 5 percent,and the company would incur a flotation cost of 15 percent if it sold new common stock.Net income for the coming year is expected to be $500,000,the firm's payout ratio is 60 percent,and its common equity ratio is 30 percent.If the firm has a capital budget of $1,000,000,what component cost of common equity will be built into the WACC for the last dollar of capital the company raises?

Question

Quizplus · Accepted Answer

The component cost of common equity that will be built into the WACC for the last dollar of capital the company raises can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a growing perpetuity) adjusted for flotation costs. The formula to calculate the cost of equity (re) is: re = (D1 / P0(1 - F)) + g, where D1 is the dividend expected at the end of the first year, P0 is the current stock price, F is the flotation cost as a decimal, and g is the growth rate. Given that D1 = $2.00 * (1 + 0.05) = $2.10 (since the dividend grows at a constant rate of 5%), P0 = $50, F = 0.15, and g = 0.05, we can substitute these values into the formula to get: re = ($2.10 / ($50 * (1 - 0.15))) + 0.05 = ($2.10 / $42.50) + 0.05 = 0.0494 + 0.05 = 0.0994 or 9.94%.

Your Company's Stock Sells for $50 Per Share,its Last Dividend