Cost of RE and New Stock

New buyers of Simmonds Inc. stock expect a return of about 22%.  The firm pays flotation costs of 9% when it issues new securities.  What is Simmonds’ cost of equity (Hint: This problem is very simple since we don’t have to estimate the investors’ return.)

a. From retained earnings?

b. From new stock?

17.  Klints Inc. paid an annual dividend of $1.45 last year.  The firm’s stock sells for $29.50 per share, and the company is expected to grow at about 4% per year into the foreseeable future.  Estimate Klints’ cost of retained earnings.

Cost of RE and New Stock: Examples 13-6 and 13-8 (pages 570 and 572)

18.       The Pepperpot Company’s stock is selling for $52.  Its last dividend was $4.50, and the firm is expected to grow at 7% indefinitely.  Flotation costs associated with the sale of common stock are 10% of the proceeds raised.  Estimate Pepperpot’s cost of equity from retained earnings and from the sale of new stock.

19.       The Longlife Insurance Company has a beta of .8.  The average stock currently returns 15% and short-term treasury bills are offering 6%.  Estimate Longlife’s cost of retained earnings.

20.       The Longlife Insurance Company of the preceding problem has several bonds outstanding that are currently selling to yield 9%.  What does this imply about the cost of the firm’s equity?

21.       Hammell Industries has been using 10% as its cost of retained earnings for a number of years.  Management has decided to revisit this decision based on recent changes in financial markets.  An average stock is currently earning 8%, treasury bills yield 3.5%, and shares of Hammell’s stock are selling for $29.44.  The firm just paid a dividend of $1.50, and anticipates growing at 5% for the foreseeable future.  Hammell’s CFO recently asked an investment banker about issuing bonds and was told the market was demanding a 6.5% coupon rate on similar issues.  Hammell stock has a beta of 1.4.  Recommend a cost of retained earnings for Hammell.

Solution: