An analyst has gathered the following information about a company: • stocks sell
ID: 2671275 • Letter: A
Question
An analyst has gathered the following information about a company:• stocks sells for $50 per share
• last dividend (D0) was $2.00
• growth rate is a constant 5 percent
• the company would incur a flotation cost of 15 percent if it sold new common stock
• net income for the coming year is expected to be $500,000
• the firm's payout ratio is 60 percent
• its common equity ratio is 30 percent
If the firm has a capital budget of $1,000,000, what component cost of common equity will be built into the weighted average cost of capital for the last dollar of capital the company raises?
A. 9.94%
B. 11.75%
C. 10.50%
D. 9.20%
Explanation / Answer
Correct answer: A ke = [D1/(Po(1-F))] + g D1(2)(1.05) = 2.1 ke = [2.1/(50 (1- .15))] + .05 = 2.1/50(.85) + .05 = 2.1/42.5 + .05 = .0494 + .05 = .0994 or 9.94%