10.1

http://webs.wichita.edu/longhofer/Fin340/Homeworks/Fin340_08S_HW9S.pdf

10.4

Current Share Value (P0) = $30
Expected annual dividend per share (D1) = $3
Constant Growth rate (g) = 5% a year
(a) What is the Company’s Cost of Common Equity if all of its equity comes from retained earnings?
Cost of Common Equity (R) = [D1 / P0] + g
Cost of Common Equity (R) = [$3 / $30] + 0.05
Cost of Common Equity (R) = 0.15 (or) 15%
Cost of Common Equity (R) = 15%
(b) If the Company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?
Cost of equity from new stock (R) = [D1 / P0 (1-flotation Cost)] + g
Cost of equity from new stock (R) = [$3 / $30 (1-0.10)] + 0.05
Cost of equity from new stock (R) = [$3 / $30 (0.9)] + 0.05
Cost of equity from new stock (R) = [$3 / $27] + 0.05
Cost of equity from new stock (R) = 0.1611 (or) 16.11%
Cost of equity from new stock (R) = 16.11%

In this case, the cost of internal equity (or retained earnings) will be equal to the required rate of return on the stock (Rs)

Here Rs = D1/P +g so, (3/30) + .05 = .10 + .05 = .15 (or 15%)

Now, you have to factor in flotation costs to find the cost of external equity...

Re (for external) =[ D1/(P*(1-F))] + g

Here Re = [3/(30*(1-.10) ]+ .05
Re = 3/(30*.90) + .05 = 3/27 + .05 = .1111 + .05

so, Re = .1611

10.6

Dividend growth rate (g) = 7% per year
Common Stock value (P0) = $23 per share
Dividend just paid (or) Last dividend (D0) = $2
Current year dividend to pay (D1) = $2.14
(a) Using the DCF approach, what is its cost of common equity?
Cost of Common Equity (R) = [D1 / P0] +g
Cost of Common Equity (R) = [$2.14 / $23] + 0.07
Cost of Common Equity (R) = 0.1630 (or) 16.30%
Cost of Common Equity (R) = 16.30%
(b) If the firm’s beta is 1.6, the risk-free rate is 9%, and the average return on the