Question

Barton Industries expects next year's annual dividend, D1, to be $2.20 and it expects dividends to grow at a constant rate g = 5%. The firm's current common stock price, P0, is $20.00. If it needs to issue new common stock, the firm will encounter a 5.8% flotation cost, F. 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. Please show work

Answer 1

Given about Barton Industries,

Next year's dividend D1 = $2.2

dividend growth g = 5%

current stock price P0 = $20

Flotation cost = 5.8%

Firms cost of equity without flotation using constant dividend growth model is

Cost of equity = D1/P0 + g = 2.2/20 + 0.05 = 16%

Cost of new equity using flotation in constant dividend growth model is

Cost of new equity = D1/(P0*(1-F)) + g = 2.2/(20*(1-0.058)) + 0.05 = 16.68%

So, flotation cost adjustment = Cost of new equity - cost of old equity = 16.68% - 16% = 0.68%