Question

Barton Industries expects next year's annual dividend, D₁, to be $2.20 and it expects dividends to grow at a constant rate g_L = 4.5%. The firm's current common stock price, P₀, is $20.30. If it needs to issue new common stock, the firm will encounter a 5.4% flotation cost, F. Assume that the cost of equity calculated without the flotation adjustment is 12% and the cost of old common equity is 11.5%. What is the flotation cost adjustment that must be added to its cost of retained earnings? Round your answer to 2 decimal places. Do not round intermediate calculations.
%

What is the cost of new common equity? Round your answer to 2 decimal places. Do not round intermediate calculations.
12 % (Correct)

Answer 1

Cost of equity=Expected dividend/Price net of floatation cost+growth

Given, expected dividend=$2.20 and growth=4.5%.

Floatation cost=5.4% and current price=$20.30.

Now, cost of equity without floatation cost=12%. and cost of old equity=11.5%.

cost of new equity=2.2/20.3(1-0.054)+0.045

=2.2/(20.3*0.946)+.0.045

=2.2/19.2038+0.045

=0.11456065986+0.045

=0.15956065986 that is 15.96%.

Floatation cost adjustment=15.96-12=3.96%

Cost of retained earnings after adjustment=11.5+3.96=15.46%.

Thus, the most appropriate cost of new equity is 15.96%.