Question

Jarett & Sons's common stock currently trades at $21.00 a share. It is expected to pay an annual dividend of $1.25 a share at the end of the year (D1 = $1.25), 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. b. If the company issued new stock, it would incur a 15% 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

Part A:

Where Investement is from Retained earnings

Ke = [ D1 / P0 ] +g

= [ $ 1.25 / $ 21 ] + 0.06

= 0.0595 + 0.06

= 0.1195 i.e 11.95%

Cost of Equity is 11.95%

Part B:

Where Investement is from new issue

Ke = [ D1 / P0 (1- Floation COst) ] +g

= [ $ 1.25 / $ 21 ( 1 - 0.15) ] + 0.06

= [ $ 1.25 / $ 17.85 ] + 0.06

0.07 + 0.06

= 0.13 i.e 13%

Cost of Equity is 13%