Question

**COST OF COMMON EQUITY WITH FLOTATION**

Banyan Co.’s common stock currently sells for $54.75 per share. The growth rate is a constant 9.6%, and the company has an expected dividend yield of 6%. The expected long-run dividend payout ratio is 20%, and the expected return on equity (ROE) is 12%. New stock can be sold to the public at the current price, but a flotation cost of 15% 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

Solution: | ||||

Cost of new equity = 16.66% | ||||

Working Notes: | ||||

Current stock price (P0) = $54.75 | ||||

growth rate (g) =9.6% | ||||

Expected Dividend (D1)=Current price x Expected dividend yield % | ||||

=$54.75 x 6% | ||||

=$3.285 | ||||

Price net of flotation cost = current price x (1-flotation cost) | ||||

=$54.75 x (1-0.15) | ||||

=$54.75 x 0.85 | ||||

=$46.5375 | ||||

Cost of new equity (Ke) = (Expected Dividend (D1)/price net of flotation cost ) + Growth rate | ||||

=($3.285/$46.5375) + 9.6% | ||||

=6.315789 % + 9.6% | ||||

=16.658823 | ||||

=16.66% | ||||

Please feel free to ask if anything about above solution in comment section of the question. |

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