Question

Ohnson Production Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of KayCee's common stock today is $40 per share. If KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. KayCee's marginal tax rate is 35%. Based on the above information, the cost of new common stock is Select one:

a. 20.09%.
b. 17.55%.
c. 26.41%.
d. 19.63%.

Answer 1

The cost of new common stock is 20.69%

Step-by-step explanation:

The formula to compute the cost of new common stock is shown below:

= Last dividend × ( 1 + Growth rate) ÷ (Current stock price - Flotation cost) + growth rate

= $3.50 × ( 1 + 0.10) ÷ ($40 - $4) + 10%

= $3.85 ÷ $36 + 10%

= 10.69 + 10%

= 20.69%

This Last dividend × ( 1 + Growth rate) = Current year dividend

We ignored the marginal tax rate