Question

Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected

dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its
common stock currently sells for $32.50 per share. New stock can be sold to the public at the
current price, but a flotation cost of 5% would be incurred. What would be the cost of retained
earnings common equity (rs) for Weaver Chocolate Co.? What would be the cost of equity from
new common stock (re)?



Cost of Retained Earnings Common Equity (rs) = ____________________.



Cost of Newly Issued Common Stock (re) = ____________________.

Answer 1

a, Cost of Retained Earnings Common Stock

Earnings per share (EPS) = $3.50

Expected dividend (D1) = 65% x $3.50 = $2.275

Current market price (Po) = $32.50

Growth rate (g) = 6% = 0.06

rs = D1/Po + g

rs = $2.275/$32.50 + 0.06

rs = 0.13 = 13%

Cost of Newly Issued Common Stock

Flotation cost = 5% = 0.05

re = D1/Po(1 - FC) + g

re = $2.275/$32.50(1 - 0.05) + 0.06

re = $2.275/$32.50(0.95) + 0.06

re = $2.275/$30.875 + 0.06

re = 0. 1337 = 13.37%

Step-by-step explanation:

Cost of retained earnings common stock is the ratio of expected dividend to current market price plus growth rate.

Cost of newly issued common stock is the ratio of expected dividend to current market price excluding flotation cost plus growth rate.