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.