Question

# Banyan Co.’s common stock currently sells for \$54.50 per share. The growth rate is a constant...

Banyan Co.’s common stock currently sells for \$54.50 per share. The growth rate is a constant 10.5%, and the company has an expected dividend yield of 6%. The expected long-run dividend payout ratio is 25%, and the expected return on equity (ROE) is 14%. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of new equity? Round your answer to two decimal places. Do not round your intermediate calculations.

We can get the cost of common equity in this case from dividend discount model.

Which is :-

Re = D1/P0(1-f) + g

Where Re = Cost of common equity

P0 = Current market price of the share

D1 = Dividends to be paid in the next period

g = Growth rate

F = Floatation cost

Now,

P0 = \$54.50

D0 = \$54.50 * 6% = \$3.27

D1 = D0(1+g) = 3.27(1+0.105) = 3.61335

g = 10.5%

F = 5%

Putting the following values in the formula, we get.

Re = 3.61335/54.50(1-0.05) + 0.105

= 3.61335/51.775 + 0.105

= 0.0697894737 + 0.105 = 0.174789474 or 17.48%

So the cost of common equity is 17.48%.