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28 November, 08:11

Eakins Inc.'s common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of common from retained earnings? 0.09% 0.19% 0.37% 0.56% 0.84%

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  1. 28 November, 08:34
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    0.37%

    Explanation:

    Since the expected payout ratio and earning per share is given, so we compute the current dividend which is shown below:

    = Earning per share * payout ratio

    = $2.75 * 70%

    = $1.925

    Now the cost of retained earning would be

    = Current year dividend : price + Growth rate

    = $1.925 : $45 + 0.06

    = 10.28%

    And, the cost of new stock would be

    = Current year dividend : price * (1 - flotation cost) + Growth rate

    = $1.925 : $45 * (1 - 0.08) + 0.06

    = 10.65%

    So, the exceed cost would be

    = 10.65% - 10.28%

    = 0.37%
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