Question

Bonanza Gold’s common stock currently sells for $32 per share. Bonanza’s investment banker charges 6.5 percent flotation costs when new common stock is issued. The company expects to pay a $3.36 per share dividend at the end of the year. If Bonanza’s cost of retained earnings is 15.5 percent, what is its cost of new common equity?

Answer 1

16.23%

Step-by-step explanation:

The formula share price below can be used to determine the cost of new common equity by making the cost of equity Ke the subject of the formula as below:

cost of retained earnings=dividend/share price+dividend growth rate

15.5%=$3.36/$32+dividend growth rate

dividend growth rate=15.5%-($3.36/$32)=5.00%

Cost of new equity=dividend/share price(net of flotation cost)+dividend growth rate

share price(net of flotation cost)=$32*(1-6.5%)=$29.92

Cost of new equity=($3.36/$29.92 )+5.00%

cost of new common equity=16.23%