Northeast Airlines has a current dividend of $1.80. Dividends are expected to grow at 7% into the foreseeable future. What is the firm's cost of equity from new stock if its shares can be sold to net the company $46 after administrative expenses (flotation costs)?

Question

Quizplus · Accepted Answer

Step 1: Calculate the expected dividend next year:

Expected dividend next year = $1.80 x (1 + 7%) = $1.93

Step 2: Calculate the cost of equity using the dividend capitalization model:

Cost of equity = (Expected dividend next year / Net proceeds from the sale of a share) + Growth rate

Cost of equity = ($1.93 / $46) + 7% = 11.17%

Rounding up to the nearest tenth, we get a cost of equity of 11.2%, which is option B.

Northeast Airlines Has a Current Dividend of $1