Copyright

Green Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow...

Question:

Green Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10% so long as it finances at its target capital structure, which calls for 55% debt and 45% common equity. Its last dividend was $2.10; its expected constant growth rate is 6%; its stock sells on the NYSE at a price of $34; and new stock would net the company $28 per share after flotation costs. GEC's marginal tax rate is 39%, and it expects to have $100 million of retained earnings this year.

GEC has two projects available:

Project A has a cost of $200 million and a rate of return of 13%, while Project B has a cost of $125 million and a rate of return of 10%. All of the company's potential projects are equally risky.

What is GEC's cost of equity from newly issued stock?

a. 15.63%

b. 16.23%

c. -16.23%

d. 16.38%

e. 15.03%

Cost of equity:

Cost of equity refers to the cost of equity financing. In case of internal equity financing, no flotation cost is incurred whereas in case of external financing flotation cost is also incurred.

Answer and Explanation:

Cost of equity from newly issued stock
= Expected dividend / Net Price + Growth rate

Expected dividend
= Current dividend x (1 + Growth rate)
= 2.10 x 1.06
= $2.226

Net Price = Price after flotation costs = $28.00

Growth rate = 6% = 0.06

So

Cost of equity from newly issued stock
= 2.226 / 28 + 0.06
= 13.95%


Learn more about this topic:

Loading...
Cost of Capital: Flotation Cost, NPV & Internal Equity

from Corporate Finance: Help & Review

Chapter 3 / Lesson 18
1.8K

Related to this Question

Explore our homework questions and answers library