Question

Barton Industries expects next year's annual dividend, D₁, to be $2.10 and it expects dividends to grow at a constant rate g = 4.5%. The firm's current common stock price, P₀, is $20.30. If it needs to issue new common stock, the firm will encounter a 5.1% flotation cost, F. Assume that the cost of equity calculated without the flotation adjustment is 12% and the cost of old common equity is 11.5%. What is the flotation cost adjustment that must be added to its cost of retained earnings? Round your answer to 2 decimal places. Do not round intermediate calculations.
%

What is the cost of new common equity considering the estimate made from the three estimation methodologies? Round your answer to 2 decimal places. Do not round intermediate calculations.
%

Answer 1

Expected div (D1) = $2.10

Expected growth (g) = 4.50%

Stock price (P0) = $20.30

Flotation cost = 5.10%

Cost of equity (considering flotation cost adjustment) = (Expected Dividend / Stock price-Flotation cost) + Expected growth

= $2.10 / (20.30-1.035) + 0.045 = 15.4%

Cost of equity (without flotation adjustment) given = 12%

Cost of old Equity = 11.5%

Flotation adjustment to be added = 15.4% - 12% = 3.4% in the retained earnings in order to make the rate equivalent to cost of equity.

Cost of new common equity :

With flotation cost = 15.4%

Without flotation cost = 12%

based on old equity =11.5% or 11.5% x 1.045 = 12.02 %