Question

Barton Industries expects next year's annual dividend, D₁, to be $2.10 and it expects dividends to grow at a constant rate g_L = 4.9%. The firm's current common stock price, P₀, is $24.60. If it needs to issue new common stock, the firm will encounter a 5.2% 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

Answer : Calculation of Flotation Cost adjustment that must be added to retained earnings:

Cost of Equity = {Expected Dividend / [Current Price * (1 - Flotation Cost)]} + growth rate

= {2.10 / [24.60 * (1 - 0.052)]} + 0.049

= {2.10 / 23.3208} + 0.049

= 0.13904836883 or 13.90%

Cost of equity calculated without the flotation adjustment is 12% and the cost of old common equity is 11.5%.

Flotation Cost adjustment = 13.90% - 12%

= 1.90%

(b.) Cost of New Common Equity = Cost of old common Equity + Flotation Cost adjustment

= 11.5% + 1.90%

= 13.40%