Question

Banyan Co.’s common stock currently sells for $39.75 per share. The growth rate is a constant 10.4%, and the company has an expected dividend yield of 6%. The expected long-run dividend payout ratio is 35%, and the expected return on equity (ROE) is 16%. New stock can be sold to the public at the current price, but a flotation cost of 10% would be incurred. What would be the cost of new equity? Round your answer to two decimal places. Do not round your intermediate calculations.

____%

Answer #1

Given

Current share price = $39.75

growth rate g = 10.4%

Dividend yield = 6%

expected dividend payout ratio = 35%

expected ROE = 16%

flotation cost = 10%

Sustainable growth rate = ROE * ( 1 - payout)

Sustainable growth rate = 16% * ( 1-35%)

Sustainable growth rate = 16% * 0.65

Sustainable growth rate = 10.40% **as
mentioned above**

Flotation cost = 10% * Price

Flotation cost = 10% * 39.75

Flotation cost = 3.975

Actual price = 39.75 - 3.975

**Actual price = $35.775**

**D1 = 6% * 39.75 = 2.385**

Actual price Price = D1 / ( k - g)

k = (D1 / Actual price ) + g

k =( 2.385 / 35.775 ) + 0.1040

k = 0.06667 + 0.1040

k = 0.170667

k = **17.07%**

**New cost of equity is 17.07%**

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