Question

Jarett & Sons's common stock currently trades at $25.00 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 8% 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. 0% b. If the company issued new stock, it would incur a 16% 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

Given for Jarett & sons's

Current stock price P0 = $25 per share

D1 = $1.25

Growth rate g = 8%

a). Using Gordon Growth model

P0 = D1/(Ke-g)

So, 25 = 1.25/(Ke-0.08) => Ke = 13%

b). Flotation cost = 16%

We know that,

P0*(1-f) = D1/(Ke-g)

So, 25*(1-0.16) = 1.25/(Ke-0.08) => Ke = 13.95%