Sentry Manufacturing paid a dividend yesterday of $5 per share. The dividend is expected to grow at a constant rate of 8% per year. The price of Sentry Manufacturing's stock today is $29 per Jure. If Sentry Manufacturing decides to issue new common stock, flotation costs will equal $2.50 per share. Sentry Manufacturing s marginal tax rate is 35%. Based on the above information, the cost of new common stock is 28.38%. 24.12%. 26.62%. 31.40%.
The cost of new common stock can be calculated using the Dividend Growth Model:
Cost of New Common Stock = (Dividend / Stock Price) + Growth Rate
The dividend is given as $5 per share, and the stock price is $29. The growth rate is 8%.
Cost of New Common Stock = (5 / 29) + 8% = 0.1724 + 0.08 = 0.2524 = 25.24%
However, we need to consider the flotation costs and the tax rate.
Flotation costs are $2.50 per share, so the effective price after flotation costs is $29 + $2.50 = $31.50.
After-tax flotation costs = Flotation costs * (1 - Tax rate) = $2.50 * (1 - 0.35) = $1.625
Cost of New Common Stock = (Dividend / (Stock Price - After-tax Flotation costs)) + Growth Rate
Cost of New Common Stock = (5 / (31.50 - 1.625)) + 8% = 0.1731 + 0.08 = 0.2531 = 25.31%
Therefore, the cost of new common stock is 25.31%, which is closest to 24.12% in the given answer choices.
To calculate the cost of new common stock, we need to use the Dividend Discount Model (DDM) formula:
Cost of new common stock = (Dividend / Price) + Growth rate - Flotation cost
Given:
Dividend = $5
Price = $29
Growth rate = 8%
Flotation cost = $2.50
First, let's calculate the dividend next year:
Dividend next year = Dividend * (1 + Growth rate) = $5 * (1 + 8%) = $5.40
Now, we can substitute the values into the formula:
Cost of new common stock = ($5.40 / $29) + 8% - $2.50
Calculating each term separately:
($5.40 / $29) = 0.1862
8% = 0.08
Cost of new common stock = 0.1862 + 0.08 - $2.50
Next, we need to calculate the after-tax flotation cost by multiplying the flotation cost by (1 - Tax rate):
After-tax flotation cost = $2.50 * (1 - 35%) = $2.50 * 0.65 = $1.625
Now, we can substitute the after-tax flotation cost into the formula:
Cost of new common stock = 0.1862 + 0.08 - $1.625
Calculating:
Cost of new common stock = 0.2662
Therefore, the cost of new common stock is approximately 26.62%.
So the correct option is: 26.62%.