Question

Barton Industries expects next year's annual dividend, D₁, to be $2.40 and it expects dividends to grow at a constant rate g = 4.4%. The firm's current common stock price, P₀, is $21.40. 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? Do not round intermediate calculations. Round your answer to two decimal places.
  %

What is the cost of new common equity considering the estimate made from the three estimation methodologies? Do not round intermediate calculations. Round your answer to two decimal places.
  %

Answer 1

Barton industries expects the next annual dividend to be $2.40. The dividends will grow at the rate of 4.4%. The current stock price is $21.40. The flotation cost involved in the new issue will be 5%. Calculate the cost of new equity as follows:

Cost of new equity = Expected Dividend / Current stock price * (1-Flotation cost) + Expected growth rate

   = $2.40 / $21.40 * (1 - 5%) + 4.4%

   = $2.40 / $ 21.40 * 0.95 + 4.4%

= $2.40 / 20.23 * 4.4%

   = 0.118635 + 4.4%

= 0.12385 or 12.385%

The cost of new equity is 12.385%