Becker Glass Corporation expects to have earnings before interest and taxes during the coming year of $1,000,000, and it expects its earnings and dividends to grow indefinitely at a constant annual rate of 12.5 percent. The firm has $5,000,000 of debt outstanding bearing a coupon interest rate of 8 percent, and it has
100,000 shares of common stock outstanding. Historically, Becker has paid 50 percent of net earnings to common shareholders in the form of dividends. The current price of Becker's common stock is $40, but it would incur a 10 percent flotation cost if it were to sell new stock. The firm's tax rate is 40 percent. What is
Becker's cost of newly issued stock?
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A. B. C. D. E.A
Cost of new common equity:
k(e) = $1.80/$40.00(1-.10) + 0.125 = 17.5%.
The dividend of $1.80 was derived by:
EBIT$1,000,000 -
Interest 400,000 -
EBT$600,000 -
Taxes (40%)240,000 -
Net income$360,000 -
EPS(1) = $360,000/100,000 = $3.60.
D(1) = $3.60(0.5) = $1.80.