Question

Jarett & Sons's common stock currently trades at $31.00 a share. It is expected to pay an annual dividend of $2.00 a share at the end of the year (D1 = $2.00), and the constant growth rate is 8% 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 14% 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 equity if retained earning is used = (D1 / share price) + growth rate

Cost of equity if retained earning is used = (2 / 31) + 0.08

Cost of equity if retained earning is used = 0.1445 or 14.45%

2)

Flotation cost = 0.14 * 31 = 4.34

Price after flotation cost = 31 - 4.34 = 26.66

Cost of equity if new equity is used = (D1 / share price) + growth rate

Cost of equity if new equity is used = (2 / 26.66) + 0.08

Cost of equity if new equity is used = 0.1550 or 15.50%