Question
Howie Ltd is trying to estimate its cost of common equity, and it has the following information. The firm has a beta of 0.90, the
Howie Ltd is trying to estimate its cost of common equity, and it has the following information. The firm has a beta of 0.90, the before-tax cost of the firms debt is 7.75%, and the firm estimates that the risk-free rate is 7% while the current market return is 12%. The firm pays dividends annually and expects dividends to grow at a constant rate of 5% indefinitely. The most recent dividend per share, paid yesterday, is $2.00. The firm thinks that its common shareholders require a 4% risk premium for assuming greater risk than the firms bondholders. Currently, the firms stock sells for $35.00 per share, but if the firm issues new shares, it will net $33.25 per share. Finally, the firm has a marginal tax rate of 34%.
1. What is the cost of internal common stock (retained earnings) using the dividend-growth model?
2. The cost of common stock using the CAPM is:
3. What is the cost of new common stock?
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