Ellington electronics wants you to calculate its cost of common stock

Finance Dec 05, 2020

Ellington electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $2.00 per share and teh current price of its common stock is $40 per share. The expected growth rate is 3%.

a) Compute the cost of retained earnings.

b) If a $3 flotation cost is involved compute the cost of new common stock.

Expert Solution

a) Computation of the cost of retained earnings:-

Cost of retained earnings = (D1 / Current price) + Growth rate

= ($2 / $40) + 3%

= 5%+ 3%

= 8%

b) Computation of the cost of new common stock:-

Cost of new common stock = (D1 / (Current price - Flotation cost)) + Growth rate

= ($2 / ($40 - $3)) + 3%

= ($2 / $37) + 3%

= 5.41% + 3%

= 8.41%

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