Question

Banyan Co.’s common stock currently sells for $35.75 per share. The growth rate is a constant 9%, and the company has an expected dividend yield of 2%. The expected long-run dividend payout ratio is 25%, 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 5% 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

Cost of equity = (D1 / (P * (1 - F))) + g

Here,

P (Price) = $35.75

D1 (Expected dividend) = Price * Expected Dividend yield

D1 = $35.75 * 2% = $0.715

F (Flotation ratio) = 5% or 0.05

g (Growth rate) = 9% or 0.09

Now, put the values into formula

Cost of equity = ($0.715 / ($35.75 * (1 - 0.05))) + 0.09

Cost of equity = ($0.715 / $33.96) + 0.09

Cost of equity = 0.0211 + 0.09

Cost of equity = 0.1111 or 11.11%

Note : ROE & dividend payout ratio is given to calculate growth rate which is already provided in the question. So, ROE & dividend payout ratio is ignored.