Question

Jarett & Sons's common stock currently trades at $35.00 a share. It is expected to pay an annual dividend of $1.75 a share at the end of the year (D1 = $1.75), and the constant growth rate is 3% a year. a. What is the company's cost of common equity if all of its equity comes from retained earnings? Do not round intermediate calculations. Round your answer to two decimal places. % b. If the company issued new stock, it would incur an 11% flotation cost. What would be the cost of equity from new stock? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

a. Company's cost of common equity

$Cost of common equity = \frac{Dividend Payable}{Current Market Price}+Growth rate of dividend$

$Cost of common equity = \frac{\$1.75}{\$35}+3\%$

$Cost of common equity = 8\%$

b. Cost of equity from new stock

$Cost of common equity = \frac{Dividend}{Issue Price (1-Flotation Cost)}+ Dividend Growth Rate$

$Cost of common equity = \frac{\$1.75}{\$35 (1-11\%)}+ 3\%$

$Cost of common equity = 8.62\%$

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