Earlier article on the computation of cost of capital for retained earnings/existing common equity/stocks
This article looks at how to compute the cost of capital from newly issued common stocks:
| Method To Compute Of Cost Of EXTERNAL Common Equity
The cost of issuing new common stock(Kne) is similar to the cost of internal equity except that a company has to incur flotation costs.
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Dividend Growth Model
Formula is Ke(Required rate of return)= D1/NPo + g Where NPo is the net proceeds per share received by the company And D1=Do(1+g) |
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Illustration Using the DIVIDEND GROWTH MODEL BASIS ON EXTERNAL COMMON EQUITY ( WITH FLOTATION COSTS) Company ABC Ltd’s recently received $0.15 dividend per share and expect dividends to growth at an annual rate of 10%. The market price of the security is $3. The flotation costs equal 15% of market price. Compute the investors’ required rate of return using the Dividend Growth Model: Suggested Solution: Ke( Required rate of return) = D1/Po + g = $0.15(1+0.1) / $3-(0.15x$3) + 0.1 = $0.165/2.55+0.1 =0.165 =16.5% |
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