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Chapter 4: Q16BP (page 365)

Murray Motor Company wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of \(2.50 per share, and the current price of its common stock is \)50 per share. The expected growth rate is 8 percent.

a. Compute the cost of retained earnings (Ke). Use Formula 11-5.

b. If a $3 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-6.

Short Answer

Expert verified

Answer

Cost of retained earnings, (Ke) is 13%.

Cost of new common stock (Kn) is 13.3%.

Step by step solution

01

 Calculation of cost of retained earnings


Costofretainedearning,(Ke)=D1P0+g=$2.50$50+8%=5%+8%=13%

02

 Calculation of cost of new common stock


Costofnewcommonstock,(Kn)=D1P0-F+g=$2.50$50-$3+8%=5.3%+8%=13.3%

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Most popular questions from this chapter

Go to Table 10-1, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) decline from 11 percent to 8 percent:

a. What is the bond price at 11 percent?

b. What is the bond price at 8 percent?

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Question:Surgical Supplies Corporation paid a dividend of $1.12 per share over the last 12 months. The dividend is expected to grow at a rate of 2.5 percent over the next three years (supernormal growth). It will then grow at a normal, constant rate of 7 percent for the foreseeable future. The required rate of return is 12 percent (this will also serve as the discount rate).

a. Compute the anticipated value of the dividends for the next three years (D1, D2, and D3).

b. Discount each of these dividends back to the present at a discount rate of 12 percent and then sum them.

c. Compute the price of the stock at the end of the third year (P3).

P3 = D4/ (Ke - g)

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