Question

A firm wishes to issue new shares of its stock, which already trades in the market. The current stock price is $24, the most recent dividend was $3 per share, and the dividend is expected to grow at a rate of 4% forever. Flotation costs for this issue are expected to be 6%. What is the required rate of return (or financing cost) in this new issue?

Answer 1

17.83%

Step-by-step explanation:

The computation of required rate of return is shown below:-

Required rate of return = ((Expected dividend ÷ (Current Stock price × (1 - Flotation cost as a percentage of issue price)) + Growth rate)) × 100

= ((Dividend × (1 + Growth rate)) ÷ Current Price of stock × (1 - Flotation cost as a percentage of issue price)) + Growth rate))) × 100

= ($3 × (1.04) ÷ $24 × (1 - 0.06) + 0.04) × 100

= ($3.12 ÷ $22.56 + 0.04) × 100

= (0.138297872 + 0.04) × 100

= 17.82978723

or

= 17.83%

Therefore we have applied the above formula.