I have a question about the cost of capital when retained earnings is involved.
• Williams can sell 8% preferred stock at par value, $105 per share. The cost of issuing and selling the preferred stock is expected to be $5 per share.
• Williams' common stock is currently selling for $100 per share. The firm expects to pay cash dividends of $7 per share next year, and the dividends are expected to remain constant. The stock will have to be underpriced by $3 per share, and flotation costs are expected to amount to $5 per share.
• Williams expects to have available $100,000 of retained earnings in the coming year; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.
Cost of new preferred stock (understood):
8.40 / (105 – 0 – 5) = 8.4%
Cost of new equity (don't understand):
New equity consists of retained earnings and/or new issues of common stock. In this case, 50% of the 200,000 of total new funds must come from equity. Since the firm has $100,000 in retained earnings, the relevant cost of new equity is the cost of retained earnings, 7 ÷ 100 + 0%, or 7.0%.
^Can anyone explain this and where the 200,000 of total new funds is coming from.
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