Question

# Banyan Co.’s common stock currently sells for \$37.75 per share. The growth rate is a constant...

Banyan Co.’s common stock currently sells for \$37.75 per share. The growth rate is a constant 7%, and the company has an expected dividend yield of 4%. The expected long-run dividend payout ratio is 30%, and the expected return on equity (ROE) is 10.0%. New stock can be sold to the public at the current price, but a flotation cost of 10% would be incurred. What would be the cost of new equity? Do not round intermediate calculations. Round your answer to two decimal places.

The cost of new equity is calculated using the gordon growth model.

Ke= DI/ Po*(1 - F) + g

where:

Ke= cost of new equity

D1= dividend at the end of year 1

Po= current stock price

F= flotation cost

g= growth rate

Dividend at the end of year 1 is calculated first.

Dividend yield= D1/ Po

4% = D1/ \$37.75

D1= 4%* \$37.75

= \$1.51

g= ROE*(1 - dividend payout ratio)

= 10%*(1 - 0.30)

= 10%*0.70

= 7%

Ke= \$1.51/ \$37.75*(1 - 0.10) + 7%

= \$1.51/ \$33.9750 + 7%

= 4.44 + 7%

= 11.44%

In case of any query, kindly comment on the solution.

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