Question

4. Problem 10.04 (Cost of Equity with and without Flotation) eBook 1 Problem Walk-Through Jarett & Sons's common stock currently trades at $22.00 a share. It is expected to pay an annual dividend of $3.00 a share at the end of the year (D1 = $3.00), and the constant growth rate is 6% 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. lo b. If the company issued new stock, it would incur a 20% 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

1)

Cost of common equity from retained earnings = (D1 / price) + growth rate

Cost of common equity from retained earnings = (3 / 22) + 0.06

Cost of common equity from retained earnings = 0.13636 + 0.06

Cost of common equity from retained earnings = 0.1964 or 19.64%

2)

Price after flotation cost = 22 (1 - 20%) = 17.6

Cost of equity = (D1 / price) + growth rate

Cost of equity = (3 / 17.6) + 0.06

Cost of equity = 0.170455 + 0.06

Cost of equity = 0.2305 or 23.05%