Question

1. Quantitative Problem: 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 $23.20. If it needs to issue new common stock, the firm will encounter a 4.7% 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. %

2. What is the cost of new common equity considering the estimate made from the three estimation methodologies? Round your answer to 2 decimal places. Do not round intermediate calculations. %

Answer 1

Solution :-

D1 = $2.40

P = ( Price ) = $23.20

b = ( Flotation cost ) = 4.7%

g = ( Growth Rate ) = 4.4%

Now Cost of New Equity = [ D1 / P*(1 - b ) ] + g

= [ $2.40 / $23.20 * (1 - 0.047 ) ] + 0.044

= [ 2.40 / 22.11 ] + 0.044

= 0.15255 = 15.255%

Cost of equity calculated without the flotation adjustment = 12%

(A) Therefore Flotation Adjustment Factor = 15.255% - 12% = 3.255%

Now

( B) Cost of New Equity = Cost of Old Equity + Flotation Cost Adjustment Factor

Cost of New Equity = 11.5% + 3.255%

= 14.76%

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