Question

Banyan Co.’s common stock currently sells for $43.75 per share. The growth rate is a constant 6%, and the company has an expected dividend yield of 4%. The expected long-run dividend payout ratio is 25%, and the expected return on equity (ROE) is 7%. 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.

Answer 1

In this question growth of 6% is given but we can also calculate growth rate using dividend pay out and return on equity.

growth rate = ROE * (1 - dividend pay out ratio) = 0.07*(1-0.25) = 5.25%

I am solving this question considering growth rates =6%.

Dividend Yield = D1 / Po

4 = (D1 / 43.75 ) *100

D1 = 1.75

Cost of equity = D1 / ((P0*(1-Flotation cost))+ g

= 1.75 / (43.75*(1-0.1)) + 0.06

= 0.10444

Cost of equity = 10.444% Answer

In case you want to consider g = 5.25%, please replace 6% in above equation with 5.25%.

Do inform me in case you have any queries.