Estimate the cost of new equity using the Gordon or dividend growth model, if last year's dividend was $2.00, the anticipated constant growth rate is 5%, the stock's selling price is $30 per share, and flotation costs are estimated to be 10%?

Question

Quizplus · Accepted Answer

The cost of new equity using the Gordon or dividend growth model can be calculated as:

Cost of Equity = (Dividend / Stock Price) + Growth Rate

Since the flotation cost is 10%, the actual amount of money the company receives per share sold is:

Net Proceeds = Selling Price * (1 - Flotation Cost)
Net Proceeds = $30 * (1 - 0.10)
Net Proceeds = $27 per share

Using this value, we can calculate the cost of new equity:

Cost of Equity = ($2.00 / $27) + 5%
Cost of Equity = 0.074 + 0.05
Cost of Equity = 0.124 or 12.4%

Therefore, the best answer is D.

Estimate the Cost of New Equity Using the Gordon or Dividend