Question

COST OF COMMON EQUITY WITH FLOTATION Banyan Co.'s common stock currently sells for $54.00 per share. The growth rate is a constant 7.8%, and the company has an expected dividend yield of 2%. The expected long-run dividend payout ratio is 35%, and the expected return on equity (ROE) is 12%. 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? Round your answer to two decimal places. Do not round your intermediate calculations. %

Answer 1

Current market Price(P0) = $54

Constant Growth rate(g) = 7.8%

- Expected Dividend Yield = Annaul dividend at the end of year (D1)/Current price

0.02 = D1/54

D1 = $1.08

Flotation Cost(F) = 10%

Calculating the Cost of new Equity (Ke):-

$Ke = \frac{D_1}{P_0(1-F)}+g$

$Ke = \frac{1.08}{54(1-0.10)}+0.078$

Ke = 10.02%

So, Cost of new equity is 10.02%

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