Question

COST OF EQUITY WITH AND WITHOUT FLOTATION Jarett & Sons’s common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of $1.00 a share at the end of the year (D1=$1.00) , and the constant growth rate is 4% a year. What is the company’s cost of common equity if all of its equity comes from retained earnings? ANSWER ↓ If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?

Answer 1

Answer:

1. 7.33%
2. 7.71%

Explanation:

1. If the company's cost of equity is;

= (Next divided/ Share price) + Dividend growth rate

= 1/30 + 4%

= 3.33% + 4%

= 7.33%

2. With the floatation costs involved, the Cost of Equity will increase as the floatation costs will increase the cost required to get equity.

= [(Next divided/ Share price - flotation costs)] + Dividend growth rate

Floatation costs = 10% * 30

= $3

= [1/30 - 3)] + 4%

= 1/27  + 4%

= 7.71%