Question

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.

Answer #1

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

Which is :-

R_{e} = D_{1}/P_{0}(1-f) + g

Where R_{e} = Cost of common equity

P_{0} = Current market price of the share

D_{1} = Dividends to be paid in the next period

g = Growth rate

F = Floatation cost

Now,

P_{0 =} $54.50

D_{0} = $54.50 * 6% = $3.27

D_{1} = D_{0}(1+g) = 3.27(1+0.105) = 3.61335

g = 10.5%

F = 5%

Putting the following values in the formula, we get.

R_{e} = 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%.**

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