Question

Trahan Lumber Company hired you to help estimate its cost of common equity. You obtained the following data: D1 = $1.25; P0 = $27.50; g = 5.00% (constant); and F = 6.00%. What is the cost of equity raised by selling new common stock?

Answer 1

If Trahan Lumber Company hired you to help estimate its cost of common equity. The cost of equity raised by selling new common stock is 9.84%.

What is the cost of equity?

The formula for the cost of equity (Ke) is:

Ke = (D1 / P0) + g

Given:

D1 = $1.25 (expected dividend next year)

P0 = $27.50 (current stock price)

g = 5.00% (constant growth rate)

F = 6.00% (flotation cost)

The adjusted dividend (D0) is:

D0 = D1 / (1 - F)

D0 = $1.25 / (1 - 0.06)

D0 = $1.25 / 0.94

D0 ≈ $1.33

Now calculate the cost of equity (Ke) using the adjusted dividend and the current stock price:

Ke = (D0 / P0) + g

Ke = ($1.33 / $27.50) + 0.05

Ke ≈ 0.0484 + 0.05

Ke ≈ 0.0984

Ke ≈ 9.84%

Therefore the cost of equity raised by selling new common stock is 9.84%.

Answer 2

The cost of equity raised by selling new common stock = 9.84%

Step-by-step explanation:

Given values, the Trahan Company has D1 = $1.25 , P0 = $27.50, g = 5%, F = 6%

Now, the company wants to calculate the cost of equity that will be arising due to the selling of new common stocks.

Below is the calculation.

Cost of equity =
`D1/(Po-F*P0) + g`

Cost of equity =
`1.25/(27.50-6%*27.50) + 5%`

Cost of equity =
`9.84%`