Question

Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $1.60 and it expects dividends to grow at a constant rate g = 4.4%. The firm's current common stock price, P0, is $22.00. If it needs to issue new common stock, the firm will encounter a 5.5% 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

Current Stock price = $22.00

Floatation cost = 5.50%

Net proceed from sale of equity = $22 × (1 - 5.50%)

= $20.79

Net proceed from sale of equity is $20.79.

Cost of equity financed externally = (Expected dividend / Net proceed) + Growth rate

= ($1.60 / $20.79) + 4.40%

= 7.70% + 4.40%

= 12.10%

Cost of equity financed externally is 12.10%.

a.

Cost of equity without floatation cost adjustment = 12%

Floatation cost adjustment = 12.10% - 12%

= 0.10%

Floatation cost adjustment is 0.10%.

b.

Cost of new equity = Cost of old equity + Floatation cost adjustment

= 11.50% + 0.10%

= 11.60%

Cost of new equity is 11.60%.