Question

Eakins Inc.'s common stock currently sells for $15.00 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 retained earnings?(Do not round your intermediate calculations.)a. 0.67%b. 0.89%c. 0.78%d. 1.12%e. 1.45%

Answer 1

Answer:

correct option is d. 1.12%

Explanation:

given data

common stock Po = $15.00 per share

earn = $2.75 per share

expected payout ratio = 70%

growth rate g = 6.00%

flotation cost f = 8%

to find out

cost of new stock exceed the cost of retained earnings

solution

first we get here  D1 = earn × payout ratio   ............1

D1 = 2.75 × 70%

D1 = $1.925

and Cost of retained earnings will be

Cost of retained earnings = D1 ÷ Po + g   ...........2

Cost of retained earnings  = $\frac{1.925}{15}$ + 6%

Cost of retained earnings  = 18.83 %

and

Cost of new equity will be

Cost of new equity =  D1 ÷ Po(1-f) + g       ...............3

Cost of new equity =  $\frac{1.925}{15(1-0.08)}$ + 6%

Cost of new equity = 19.95 %

so excess of cost of new equity over cost of retained earnings will be

excess of cost of new equity over cost of retained earning = 19.95 % - 18.83 %

excess of cost of new equity over cost of retained earning = 1.12 %

so correct option is d. 1.12%