If a firm plans to issue new stock, flotation costs (investment
bankers' fees) should not be ignored. There are two approaches to
use to account for flotation costs. The first approach is to add
the sum of flotation costs for the debt, preferred, and common
stock and add them to the initial investment cost. Because the
investment cost is increased, the project's expected return is
reduced so it may not meet the firm's hurdle rate for acceptance of
the project. The second approach involves adjusting the cost of
common equity as follows:
The difference between the flotation-adjusted cost of equity and the cost of equity calculated without the flotation adjustment represents the flotation cost adjustment.
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 gL = 4.9%. The firm's current common stock price, P0, is $21.40. If it needs to issue new common stock, the firm will encounter a 4.7% 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? Round your answer to 2 decimal places.
Do not round intermediate calculations.
SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE
I HAVE CALCULATED FLOTATION COST ADJUSTMENT AS WELL AS CORRECT COST OF EQUITY
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