Question

5. Flotation costs and the costs of new debt and equity capital Aa Aa Read each of the following statements, and indicate whether each statement is true or false. False True O Statement The cost of retained earnings and the cost of new common stock are calculated in the same manner, except that the cost of the new shares is based on the value of the firm's share price net of its flotation cost, while the cost of a firm's retained earnings is based solely on the share's expected future cash flows, its current market price, and the expected rate of growth of the firm's earnings and the share's dividends. One disadvantage of a CAPM-based estimate of a cost of new or existing equity is that it is impossible to incorporate flotation costs into the estimate. One reason that flotation costs associated with the sale of new equity is significantly greater than those associated with the sale of new debt is the difference in number and characteristics of the purchasers of the new securities o o o o Consider the case of Sunny Day Manufacturing Company: Sunny Day Manufacturing Company has a current stock price of $30 per share, and is expected to pay a per-share dividend of $3.80 at the end of next year. The company's earnings and dividends growth rate are expected to grow at a constant rate of 3.90% into the foreseeable future. If White Lion expects to incur flotation costs of 3.90% of the value of its newly-raised equity funds, then the flotation-adjusted (net) cost of its new common stock (rounded to two decimal places) should be 13.66% 20.50% 18.79% 17.08%

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5. Flotation costs and the costs of new debt and equity capital Aa Aa E Read each of the following statements, and indicate whether each statement is true or false. True False TRUE Statement The cost of retained earnings and the cost of new common stock are calculated in the same manner, except that the cost of the new shares is based on the value of the firm's share price net of its flotation cost, while the cost of a firm's retained earnings is based solely on the share's expected future cash flows, its current market price, and the expected rate of growth of the firm's earnings and the share's dividends. One disadvantage of a CAPM-based estimate of a cost of new or existing equity is that it is impossible to incorporate flotation costs into the estimate. One reason that flotation costs associated with the sale of new equity is significantly greater than those associated with the sale of new debt is the difference in number and characteristics of the purchasers of the new securities. FALSE TRUE Consider the case of Sunny Day Manufacturing Company: Sunny Day Manufacturing Company has a current stock price of $30 per share, and is expected to pay a per-share dividend of $3.80 at the end of next year. The company's earnings and dividends growth rate are expected to grow at a constant rate of 3.90% into the foreseeable future. If White Lion expects to incur flotation costs of 3.90% of the value of its newly-raised equity funds, then the flotation-adjusted (net) cost of its new common stock (rounded to two decimal places) should be 13.66% 20.50% 18.79% 17.08%

Cost of new common stock => Dividend +Growth rate Price per sharex(1- Flotation costs)

= 3.8 / [30 x (1 - 3.90%)] + 3.90% = 17.08%

Hence, the correct answer is 17.08%. Please choose 17.08% from the drop down.