Final answer:
The cost of new common stock issuance can be calculated using the dividend discount model, incorporating expected dividends, net proceeds from the sale of the stock, and the growth rate of dividends.
Step-by-step explanation:
The student is asking how to calculate the cost of new common stock being issued by a firm, considering the effects of dividends, underpricing, and flotation costs. The cost of new stock issuance can be determined by considering the expected dividend payment, the net proceeds from the sale of the stock after accounting for underpricing and flotation costs, and the current market price of the stock. In this scenario, to calculate the cost of equity (k), we use the formula:
k = (D1 / P0) + g
Where:
- D1 = expected dividend per share at the end of the coming year
- P0 = net proceeds from the sale of the stock (market price - underpricing - flotation costs)
- g = growth rate of dividends
The expected dividend (D1) is given as $5.61 and is to be received at the end of the coming year. The net proceeds from selling the stock (P0) will be the market price of $100 minus the $2 underpricing and $1 flotation cost, which equals $97. To find the growth rate of dividends (g), we look at the historical dividends and calculate it based on the increase from year to year, then average out these rates.
Once we have all these values, we can plug them into our cost of equity formula to get the right answer, which should match one of the provided choices (A, B, C, or D).