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 equity from new common stock?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 equity from new common stock?

Answer 1

Cost of Equity = 13.36%

Step-by-step explanation:

Cost of Equity is required = ??

Discounted Dividend Model or DDM model can be used to calculate cost of equity from new common stock.

Before starting to solve, let's find out what have been given already:

Earnings = 3.50 USD

Payout Ratio = 65%

G = Growth Rate = 6.0%

F = Flotation Cost = 5%

P = Current Share Price = 32.50 USD

First Step is to find out the expected dividend.

Dividend = Expected Earning x Payout Ratio

Dividend = 3.50 x 65%

D = Dividend = 2.275 USD

So, now we have everything on board, let's find out cost of equity.

Cost of Equity =
`(D)/(P(1-F))` + G

Cost of Equity =
`(2.275)/(32.50(1-0.05))` + 0.06

Cost of Equity = 13.36%