Question

Quantitative Problem: Barton Industries expects next year's annual dividend, D₁, to be $1.80 and it expects dividends to grow at a constant rate g = 4.7%. The firm's current common stock price, P₀, is $24.70. If it needs to issue new common stock, the firm will encounter a 5.5% flotation cost, F. Assume that the cost of equity calculated without the flotation adjustment is 12% and the cost of old common equity is 11.5%. What is the flotation cost adjustment that must be added to its cost of retained earnings? Do not round intermediate calculations. Round your answer to two decimal places.
  %

What is the cost of new common equity considering the estimate made from the three estimation methodologies? Do not round intermediate calculations. Round your answer to two decimal places.
  %

Answer 1

Details given

D1 = $1.8

Dg =4.7%

P0 =$24.70

F =  5.5%

Cost of equity without flotation costs = 12%

Cost of Old common equity = 11.5%

1) Cost of new common equity

Cost of equity with flotation costs

= D1 / P0(1-F)+Dg

= 1.8 / 24.70 (1-5.5%)+4.7%

= 1.8 / 24.70 (0.945)+4.7%

= 1.8 / 22.68 + 4.7%

= 7.94% + 4.7%

= 12.64%

2) Flotation cost adjustment to retained earnings

Flotation adjustment is the difference between cost new equity including Flotation costs less Cost of equity without flotation costs

= 12.64% - 12%

= 0.64%