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LePage Co. expects to earn $2.50 per share during the current year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its common stock currently sells for $24.75 per share. New stock can be sold to the public at the current price, but a flotation cost of 10% would be incurred.
What would be the cost of equity from new common stock(re)?Cost of Retained Earnings Common Equity (rs) = .Cost of Newly Issued Common Stock (re) = .

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Answer and Explanation:

The computation is shown below:

As we know that

Current price (Po) = Expected Dividend ÷ (Cost of Retained Earning - growth rate)

where,

Expected Dividend is

= $2.50 × 65% × 1.06

= $1.7225

The Current price is $24.75

And the growth rate is 6%

So,

Cost of Retained Earning is

= $1.7225 ÷ 24.75 + 0.06

= 12.96%

Now the cost of equity from the common stock is

But before that the current price after floatation cost is

= Expected Dividend ÷ (Cost of Newly Issued Common Stock - growth rate)

where,

Expected Dividend is

= $2.50 × 65% × 1.06

= $1.7225

The Current price after floatation Cost is

= $24.75 - 10% × $24.75

= $22.275

The growth rate is 6%

Now

Cost of Newly Issued Common Stock is

= $1.7225 ÷ $22.275 + 0.06

= 13.73%

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