Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0%. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of equity from new common stock?

Cost of equity= 6.2%

Explanation:

According to the dividend valuation, the value of a stock is the present value of expected future dividends discounted at the required rate of return.

The model can me modified to determined the cost of equity having flotation cost as follows:

Cost of equity = D(1+r )/P(1-f) + g

Dividend(D)= 65%× 3.50 = 2.275

d- dividend,

p- price of stock - $32.50

f - flotation cost : 5%

g- growth rate : 6%

Applying this to the question;

cost of equity

=(2.275×/(32.50×(1-0.05))) + 0.06

= 6.2%

the correct answer is b.)