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Expected cash dividends are $4
Expected cash dividends are $4.50, the dividend yield is 8%, flotation costs are 5%, and the
growth rate is 4%. Compute cost of the new common stock.
A) 12.42%
B) 8.42%
C) 4.21%
D) not enough information to calculate the cost.
Expert Solution
Computation of the cost of new common stock:-
Dividend yield = Annual dividends / Current price
8% = $4.50 / Current price
Current price = $4.50 / 8%
= $56.25
Cost of new common stock = (D1 / (Current price*(1-Floatation costs))) + Growth rate
= (4.50 / ($56.25 * (1 - 5%))) + 4%
= ($4.50 / $53.44) + 4%
= 8.42% + 4%
= 12.42%
Correct option is A) 12.42%
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