Question

Hofstadler Inc.’s common stock currently trades at $105.25 per share. It is expected to pay an annual dividend of $4.50 at the end of the year, and the constant growth rate is 4.0% a year.  

a. What is the company’s cost of retained earnings (internal equity)?
b. What is the company’s cost of new stock, if flotation costs are 5%?

Answer 1

a. cost of internal equity is computed as shown below:

= (Annual dividend / current price) + growth rate

= ($ 4.50 / $ 105.25) + 4%

= 8.28% Approximately

b. cost of new stock is computed as follows:

= [ (Annual dividend) / [ (current price x (1 - flotation cost) ] ] + growth rate

= [ ($ 4.50) / [ ($ 105.25 x (1 - 0.05) ] ] + 4%

= 8.50% Approximately

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