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As the winner of a contest, you are now CFO for the day for Maguire Inc. and your day's job involves raising capital for expansion. Maguire's common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of common from reinvested earnings?

a. 0.09%
b. 0.19%
c. 0.37%
d. 0.56%
e. 0.84%

Answer :

Answer:

cost of common equity change = 0.37 %

so correct option is c. 0.37%

Explanation:

given data

common stock sell = $45.00 per share

expects earn = $2.75 per share

expected payout ratio = 70%

expected constant growth rate = 6.00%

flotation cost = 8%

to find out

how much would the cost of new stock exceed the cost of common

solution

we will apply here dividend payout ratio equation that is express as

dividend payout ratio = [tex]\frac{DPS}{EPS}[/tex]    ....................1

put here value we get

0.70 = [tex]\frac{DPS}{2.75}[/tex]

DPS = $1.925

so cost of equity will be

cost of equity = [tex]\frac{DPS}{common\ stock}[/tex] + growth rate    ........2

cost of equity = [tex]\frac{1.925}{45}[/tex] + 6%

cost of equity = $10.28

and cost of new equity is =  [tex]\frac{DPS}{common\ stock-(common\ stock*f)}[/tex] + growth rate    ........3

cost of new equity = [tex]\frac{1.925}{45-45*0.08}[/tex] + 6%

cost of new equity = 10.65 %

so we can say stock price is decrease here

so cost of common price increase

hence cost of common equity change = $10.65 - $10.28

cost of common equity change = 0.37 %

so correct option is c. 0.37%

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