A firm has to pay 1.5% fee to underwriters when it issues new equity. The firm has a dividend payout ratio of 37% and a return on equity of 13.9%. The firm has just announced earnings of $3.27 per share. If the stock's cost of external equity is 14.9%, how much capital would the firm raise by issuing 6 million shares?
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A. B. C. D.D
IF F is the percentage flotation cost and P is the amount of new equity raised per new share, then
P = D1/[(Ke - g)(1-F)], where Ke is the cost of external equity and D1 is next year's expected dividend.
Also, g = ROE*retention ratio = ROE*(1-payout ratio) = 13.9%*(1-37%) = 8.76%. D1 = 3.27*0.37*(1+8.76%) = $1.316. Therefore, P = 1.316/[(1-1.5%)*(14.9% -
8.76%) = $21.76. By issuing 6 million shares, the firm will therefore raise 6*21.74 = $130.55 million.