Messman Manufacturing will issue common stock to the public for $30. The expected dividend and...

Question:

Messman Manufacturing will issue common stock to the public for $30. The expected dividend and the growth in dividends are $3.00 per share and 5%, respectively.

If the floating cost is 2% of the issue proceeds, then what is the after-tax cost of debt? Disregard the tax shield from the amortization of flotation costs.

Flotation Cost of Stock Issues:

When firm issue stocks, the flotation costs are the expenses associated with the issuance. A major component of flotation costs is the underwriting fees, which are charged by the investment banks for selling the stocks to the public.

Answer and Explanation:

We can use the dividend growth model to compute the cost of equity, as follows:

  • cost of equity = expected dividend / (price per share - flotation cost) + dividend growth rate
  • cost of equity = 3 / (30 - 30 * 2%) + 5%
  • cost of equity = 15.20%

That is, the cost of equity for the firm is 15.20%.


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
9.7K

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