Question

Barton Industries expects next year's annual dividend, D1, to be $1.60 and it expects dividends to grow at a constant rate g = 4%. The firm's current common stock price, P0, is $20.70. If it needs to issue new common stock, the firm will encounter a 5.7% 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.

What is the cost of new common equity considering the estimate made from the three estimation methodologies? Round your answer to 2 decimal places. Do not round intermediate calculations.

Answer 1

Next year's dividend, D1 = 1.60

Dividednd growth, g = 4% or 0.04

Cirrent stock price, p0 = 20.70

Floataion cost,f = 5.7% or 0.057

Cost of issuance of new equity, re = D1 / [p0 * ( 1 - f)] + g

Cost of issuance of new equity, re = 1.60 / [ 20.70 * ( 1 - 0.057)] + 0.04

Cost of issuance of new equity, re = (1.60 / 19.5201 ) + 0.04

Cost of issuance of new equity, re = 0.1219 67or 12.1967%

So, flotation cost adjustment = 12.1967% - cost of equity calculated without the flotation

So, flotation cost adjustment = 12.1967% - 12%

flotation cost adjustment = 0.1967%

Cost of new common equity = old cost of equity + flotation adjustment

Cost of new common equity = 11.5% + 0.1967%

Cost of new common equity = 11.6967%

(Three methods to calculate cost of equity are Capital asset pricing method, Dividend discount model and bond yield plus risk premium)