Problem 11-16 Costs of retained earnings and new common stock [LO3] Murray Motor

Question

Problem 11-16 Costs of retained earnings and new common stock [LO3] Murray Motor Company wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $2.50 per share, and the current price of its common stock is $50 per share. The expected growth rate is 8 percent. a. Compute the cost of retained earnings (Ke). Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) b. If a $3 flotation cost is involved, compute thecost of new common stock (Kn). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Input variables: K is cost of common equity in the form of retained earnings D, is dividend at the end of the 1st year or period Dividends Year 1 $2.50 Stock price Growth rate Flotation cost $50 0.08 $3 Ke - (D1/Po)g Po is price of the stock today g is grouth rate in dividends Kn is cost of new common stock K, (D,/(PoD, is dividend at the end of the 1st year or period Po is price of the stock today Fis flotation, or selling, cost g is grouth rate in dividends Solution and Explanation: Cost of retained earnings b. Cost of new equity

Explanation / Answer

a. cost of retained earnings = (2.50/50) + 0.08 = 0.13

b. cost of new equity = (2.50/50-3) + 0.08 = 0.1332

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