Question

Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $1.70 and it expects dividends to grow at a constant rate g = 4.6%. The firm's current common stock price, P0, is $25.00. If it needs to issue new common stock, the firm will encounter a 4.8% flotation cost, F. What is the flotation cost adjustment that must be added to its cost of retained earnings? Do not round intermediate calculations. Round your answer to two decimal places. % What is the cost of new common equity considering the estimate made from the three estimation methodologies? Do not round intermediate calculations. Round your answer to two decimal places

Answer 1

a)

To find the flotation adjustment, we first compute the implied required return on the new stock, using the dividend growth model:

Required return = next dividend / (price * (1 - flotation cost)) + dividend growth rate

required return = $1.7 / ($25.00 * (1 - 4.8%)) + 4.6%

required return = 11.74%

Now, cost of equity without flotation cost =

= ( $1.7 / $25.00 ) + 4.6% = 11.4%

The flotation adjustment cost = required return on new stocks - required return on equity without adjustment

= 11.74% - 11.4% = 0.34%

b) The cost of new common equity = cost of old common equity + flotation adjustment

Here in the question cost of old equity is missing so not able to do such part.