Question

Quantitative Problem: Barton Industries expects next year's annual dividend, D₁, to be $1.90 and it expects dividends to grow at a constant rate g = 4.6%. The firm's current common stock price, P₀, is $22.10. If it needs to issue new common stock, the firm will encounter a 4.4% 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.
Ans: %

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.
Ans: %

Answer 1

Current Stock price = $22.10

Floatation cost = 4.40%

Net proceed from sale of equity = $22.10 × (1 - 4.40%)

= $21.1276

Net proceed from sale of equity is 21.1276

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

= ($1.90 / $21.1276) + 4%

= 8.99% + 4.60%

= 13.39%

Cost of equity financed externally is 13.39%.

a.

Cost of equity without floatation cost adjustment = 12%

Floatation cost adjustment = 13.39% - 12%

= 1.39%

Floatation cost adjustment is 1.39%.

b.

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

= 11.50% + 1.39%

= 12.89%

Cost of new equity is 12.89%