Question

9. Problem 10.13 (Cost of Common Equity with Flotation) еВook Banyan Co.'s common stock currently sells for $39.75 per share. The growth rate is a constant 5%, and the company has an expected dividend yield of 3%. The expected long-run dividend payout ratio is 40%, and the expected return on equity (ROE) is 8%. New stock can be sold to the public at the current price, but a flotation cost of 10% would be incurred. What would be the cost of new equity? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Cost of equity K_{​​​​​​e} = (DIV_​1 / stock price)+ growth rate

Div_​0 = Share price* ROE*PAYOUT RATIO

Div_{​0 = 39.75*0.08*0.40= 1.272}

so,DIV_{​1 =} Div0*(1+groth rate)

= 1.272*(1+0.05)

= 1.3356

Now, what will we consider as the stock price??

here from stock price we will deduct the flotation cost.

= 39.75- (39.75*0.10)

= 35.775

Now, let's come to our main formula:-

Cost of equity K_{​​​​​​e} = (DIV_​1 / stock price)+ growth rate

= (1.3356/35.775)+ 0.05

= 0.0373+0.05

= 0.0873

That means the cost of equity = 8.73%.