Question

Common stock : The firm's common stock is selling at RM 60. The floatation cost is 3 percent of selling price. At present, the company's growth rate is 5 percent and the latest dividend paid was RM 0.90. Calculate the cost of each alternative if the company is in a 40 percent tax bracket

Answer 1

D₁ = is the dividend will be paid next year

D₁ = D_O $\times$ (1+g)

D_O = Dividend just paid, latest or latest dividend paid, last year dividend paid

D₁ = 0.90 ( 1 + 0.05)

D₁ = 0.90 ( 1.05)

D₁ = 0.945 

D1 = 0.945

Selling price, SP = 60

Floatation cost, FC = 3$\%\times$ 60 = 1.80

Growth rate, G = 0.05 OR 5$\%$

Effective rate=$\frac{D1}{(SP – FC)} + G$

= $\frac{0.945}{(60– 1080)} + 0.05$

= $\frac{0.945}{58.2} + 0.05 = 0.06623\times100\% = 6.62\%$

The best alternative for the company is using Common Stock Financing because effective rate (6.62%) is lower.