Williamson Manufacturing paid a $2 dividend last year and expects dividends to grow at a constant rate of 7%. The firm's stock is selling at $45 per share and flotation costs on a new issue would be 15%. Calculate Williamson's cost of new equity.

Question

Quizplus · Accepted Answer

First, we need to calculate the expected dividend for the next year:
Expected Dividend = $2 x (1+0.07) = $2.14

Next, we need to calculate the cost of new equity using the dividend growth model:
Cost of New Equity = (Expected Dividend / Current Stock Price) + Growth Rate
Cost of New Equity = ($2.14 / $45) + 0.07 = 0.113 or 11.3%

However, we need to adjust for flotation costs of 15%, which reduces the net proceeds from the new issue:
Net Proceeds = (1 - 0.15) x $45 = $38.25

Using this adjusted stock price, we can recalculate the cost of new equity:
Cost of New Equity = ($2.14 / $38.25) + 0.07 = 0.126 or 12.6%

Therefore, the answer is C (12.6%).

Williamson Manufacturing Paid a $2 Dividend Last Year and Expects