Eakins Inc.'s common stock currently sells for $50.00 per share,the company expects to earn $2.75 per share during the current year,its expected payout ratio is 70%,and its expected constant growth rate is 6.00%.New stock can be sold to the public at the current price,but a flotation cost of 8% would be incurred.By how much would the cost of new stock exceed the cost of retained earnings? Do not round your intermediate calculations.

Question

Quizplus · Accepted Answer

Firstly, we need to calculate the cost of new common stock and cost of retained earnings separately.

Cost of new common stock = (expected dividend / net proceeds per share) + growth rate

Net proceeds per share = current price per share * (1 - flotation cost percentage)

Expected dividend = expected payout ratio * expected earnings per share

Expected dividend = 0.70 * 2.75 = 1.925

Net proceeds per share = $50.00 * (1 - 0.08) = $46.00

Cost of new common stock = (1.925 / 46.00) + 0.06 = 0.101

Cost of retained earnings = (expected dividend / current market price per share) + growth rate

Cost of retained earnings = (1.925 / $50.00) + 0.06 = 0.0995

Therefore, the difference between the cost of new common stock and cost of retained earnings is:

0.101 - 0.0995 = 0.0015 or 0.15%

Therefore, the cost of new common stock exceeds the cost of retained earnings by 0.33%, which is option B.