Question

Jarett & Sons's common stock currently trades at $34.00 a share. It is expected to pay an annual dividend of $1.50 a share at the end of the year (D1 = $1.50), and the constant growth rate is 4% a year. What is the company's cost of common equity if all of its equity comes from retained earnings? Round your answer to two decimal places. Do not round your intermediate calculations. % If the company issued new stock, it would incur a 9% flotation cost. What would be the cost of equity from new stock? Round your answer to two decimal places. Do not round your intermediate calculations. %

Answer 1

1)

cost of common equity if equity comes from retained earnings = (D1 / share price) + growth rate

cost of common equity if equity comes from retained earnings = (1.5 / 34) + 0.04

cost of common equity if equity comes from retained earnings = 0.1241 or 12.41%

2)

Flotation cost = 0.09 * 34 = 3.06

Price after flotation cost = 34 - 3.06 = 30.94

cost of common equity if issued new stock = (D1 / share price) + growth rate

cost of common equity if issued new stock = (1.5 / 30.94) + 0.04

cost of common equity if issued new stock =0.0885 or 8.85%