D1 kn g p0 f kncostofsaleofnewcommonstock

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Unformatted text preview: uity – Dividend Growth Model kS = D1 +g P0 Example: Example: The market price of a share of common stock is $60. The prior dividend (D0) is $3, and the expected growth rate is 10%. (D1 = 3.00 x 1.10 = 3.30) kS = 3.30 60 + .10 =.055 + .10 = 15.5% =.055 3. Compute Cost of Common Equity Cost of New Common Stock – Must adjust the Dividend Growth Model equation for flotation (F) costs of the new common shares. D1 kn = +g P0 - F Kn = cost of sale of new common stock D1 is the next dividend to be paid Po is the current market price of shares outstanding F is the flotation cost G is the rate of growth 17 17 3. Compute Cost of Common Equity Example: Example: If additional shares are issued, floatation costs will be 12% of price per share. D0 = $3.00 and estimated growth is 10%, Price is $60 as before. Flotation cost = $60 x .12 = $7.20. (Po – F = $60.00 – 7.20 = $52.80) (D1 = 3.00 x 1.10 = 3.30) kn = 3.30 + .10 52.80 = .0625 + .10 = 16.25% 18 18 Weighted Average Cost of Capital Weighted Gallagher Corporation estimates the following costs for each component in its capital structure: Source of Capital Cost Bonds (after tax) kd = 6.0% Preferred Stock kp = 11.9% Common Stock Retained Earnings ks = 15.5% New Shares kn = 16.25% Gallagher’s tax rate is 40% 19 19 Weighted Average Cost of Capital If using retained earnings (Internal Equity) to finance the equity portion: WACC = (WTd x AT kd ) + (WTp x kp ) + (WTs x ks) WACC = weighted average cost of capital WT = the weight, or percentage of each element of capital (% of debt, preferred and common stock to total assets) ATkd = after tax cost of debt Kp = Cost of preferred stock Ks = Cost of equity (Internal – retained earnings) Weighted Average Cost of Capital Weighted If using retained earnings (internal equity) to finance the common equity portion : WACC= ka= (WTd x AT kd ) + (WTp x kp ) + (WTs x ks) Assume that Gallagher’s desired capital structure is 40% debt, 10% preferred and 50% common equity. 21 21 Weighted Average Cost of Capital If using retained earnings (Internal Equity) to finance the equity portion: WACC = (WTd x AT kd ) + (WTp x kp ) + (WTs x ks) Assume that Gallagher’s desired capital structure...
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This document was uploaded on 02/19/2014.

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