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Co. plans to finance its capital budget

2 Questions, don’t handshake if you aren’t familiar with finance.


ABC Co. expects to earn $3.65 per share during the current year, its

expected dividend payout ratio is 66%, its expected constant dividend growth rate (g) is 5.0%,

and its common stock currently sells for $33.50 per share.  New stock can be sold to the public at

the current price, but a flotation cost of 10% would be incurred (F = 0.10).  What would be the

cost of retained earnings  common equity (rs) for ABC Co.?  What would be the cost of equity from new common stock (re) (Assume the new stocks issue at the same price as existing stock)?


Co. plans to finance its capital budget for next year by selling $60 million of 10 percent semiannual coupon rate bonds, with each bond having a maturity value (par value) of $1,000 and a 15-year maturity.  Flotation costs (F) will be 4% of the maturity value of each bond.  The balance of its $125 million capital budget will be financed with retained earnings (so that retained earnings will be at least $65 million next year).  Next year CDE expects dividends will increase at a 9 percent rate from $1.40 per share (so that D0 = $1.40), and the CFO expects dividends and earnings to continue growing at the 9 percent rate for the foreseeable future. The current market value of CDE’s stock is $40.  The firm has a marginal tax rate of 35 percent.  Given its flotation cost on newly issued debt what is the cost of debt for CDE (rd)?

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