Question

**Quantitative Problem:** Barton Industries expects
next year's annual dividend, D_{1}, to be $1.70 and it
expects dividends to grow at a constant rate g_{L} = 4.7%.
The firm's current common stock price, P_{0}, is $24.50. If
it needs to issue new common stock, the firm will encounter a 5%
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.

%

Answer #1

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**Answer:**

a)

To find the flotation adjustment, we first compute the implied required return on the new stock, using the dividend growth model:

Required return = next dividend / (price * (1 - flotation cost)) + dividend growth rate

required return = $1.7 / ($24.50 * (1 - 5%)) + 4.7%

required return = 12.004%

flotation cost adjustment factor=12.004 - 12 = 0.00

b)

cost of new equity=11.5%+0.004% = 11.504% ~ 11.50%

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