Global Advertising Company
The Global Advertising Company had net income after interest but before taxes of $40,000 this year. The marginal tax rate is 40 percent, and the dividend payout ratio is 30 percent. The company can raise debt at a 12 percent interest rate for any amount of debt less than $8,000. If the firm raises $8,000 or more of debt, a 15 percent interest rate will apply to that new debt. The last dividend paid by Global was $0.90. Global's common stock is selling for $8.59 per share, and its expected growth rate in earnings and dividends is 5 percent. If Global issues new common stock, the flotation cost incurred will be 10 percent. Global plans to finance all capital expenditures with 30 percent debt and 70 percent equity.
-Refer to Global Advertising Company.What is the cost of common equity raised by selling new stock?

Question

Quizplus · Accepted Answer

To calculate the cost of common equity raised by selling new stock, we use the dividend growth model:

Cost of Equity = (Next Year's Dividend / Current Price per Share) + Growth Rate + Flotation Cost

Next year's dividend = $0.90 x (1 + 5%) = $0.945 
Current price per share = $8.59 
Growth rate = 5% 
Flotation cost = 10%

Cost of Equity = ($0.945 / $8.59) + 5% + 10% = 17.22%

Global Advertising Company the Global Advertising Company Had Net Income After Interest but After