Question

# Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be \$1.70 and it expects...

Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be \$1.70 and it expects dividends to grow at a constant rate gL = 4.7%. The firm's current common stock price, P0, 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.
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What is the cost of new common equity? Round your answer to 2 decimal places. Do not round intermediate calculations.
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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%