US CMA Part 2 · Chapter 3 · Question 12 of 15
Carrow Media plans to issue new common stock at $40.00 per share. Flotation costs are 6% of the issue price. The next dividend is expected to be $1.80 and dividends are expected to grow at 5% per year. What is the cost of new common equity (rounded to two decimals)?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) 9.79%
Explanation
Net proceeds per share = $40.00 x (1 - 6%) = $37.60. Cost of new equity = D1 / net proceeds + g = $1.80 / $37.60 + 5% = 4.79% + 5.00% = 9.79%. Ignoring flotation costs gives 9.50%, which is the cost of retained earnings rather than new stock.
More Corporate finance: risk and return, long-term financing and cost of capital MCQs
- Q14Ellery Corp. expects to generate $1,200,000 of retained earnings next year. Its target capital structure is 60% common equity and 40%…
- Q15Which of the following is an advantage of long-term debt financing compared with issuing common stock?
- Q1An analyst estimates the following one-year returns for Westbrook Corp. stock: Strong economy (probability 0.30): 18% Normal economy…
- Q2Using the same three scenarios for Westbrook Corp. (probabilities 0.30, 0.50 and 0.20; returns 18%, 10% and -4%; expected return 9.6%)…
- Q3Investment A has an expected return of 12% and a standard deviation of 9%. Investment B has an expected return of 8% and a standard…