Question

Keystone Corporation will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock be for Keystone Corp.?A) 11.33%B) 11.51%C) 11.60%D) 11.79%E) 12.53%

Answer 1

D) Ke = 11.79%

Step-by-step explanation:

We will use the gordon dividen grow model to sovle for the cost of new equity

`(divends)/(return-growth) = Intrinsic \: Value`

we clear for return

`return = (divends)/(Stock) + grow`

in this case we call the retun cost of equity

and we consider the impact of flotation ost, because this is new equity, which reduce the proceeds from the stock

`cost \:of \:new \:equity= (divends)/(Stock (1-F)) + grow`

next year dividend 1.50 x 1.08 = 1.62

flotation cost 5% = 0.05

Stock 45

grow 0.08

`Ke= (1.62)/(45(1-0.05) + 0.08`

Ke = 0.117894737 = 11.79%