Use the dividend growth model to determine the required rate of return for equity. Your firm intends to issue new common stock. Your investment bankers have determined that the stock should be offered at a price of $45.00 per share and that you should anticipate paying a dividend of $1.50 in one year. If you anticipate a constant growth in dividends of 3.00% per year and the investment banking firm will take 5.00% per share as flotation costs, what is the required rate of return for this issue of new common stock?

Required rate of return = 6.5%

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

d - dividend, p - price of stock, f - flotation cost, - g - growth rate

D-1.50, p - 45.00 f - 5% g - 3%

Applying this to the question;

cost of equity - 1.50/45.00 * (1-0.05) + 0.03

= 6.5%

Required rate of return = 6.5%