Question

Jarett & Sons's common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of $1.25 a share at the end of the year (D1 = $1.25), and the constant growth rate is 4% a year. What is the company's cost of common equity if all of its equity comes from retained earnings? Round your answer to two decimal places. Do not round your intermediate calculations. % If the company issued new stock, it would incur a 12% flotation cost. What would be the cost of equity from new stock? Round your answer to two decimal places. Do not round your intermediate calculations.

Answer 1

Ans a)

Company's cost of common equity if all of its equity comes from retained earnings:

Cost of common equity= D₁/P₀ +g

Where

D₁=$1.25

P₀=$30

G= 4%

Cost of common equity= $1.25/30 + .04

Cost of common equity= .0816 or 8.16%

Ans b)

Cost of equity from new stock= D₁/P₀(1- Floatation cost) +g

Floatation cost= 12%

Cost of equity from new stock= $1.25/30(1- 12%) +.04

Cost of equity from new stock= $1.25/30(.88) +.04

Cost of equity from new stock= .0473 +.04        

Cost of equity from new stock= .0873 or 8.73%