Quantitative Problem: Barton Industries expects next year\'s annual dividend, D1
ID: 2720953 • Letter: Q
Question
Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $2.10 and it expects dividends to grow at a constant rate g = 4.6%. The firm's current common stock price, P0, is $21.70. If it needs to issue new common stock, the firm will encounter a 5.8% 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.
___%
Explanation / Answer
Current stock price (P0) = $ 21.70
Dividend of next year (D1) = $ 2.10
Expected constant growth rate (g) = 4.6% = 0.046
As per Gordon’s growth model, P0 = D1/(k-g) where k is the cost of equity.
Therefore, k = 14.28%
Considering a floatation cost of 5.80%, the effective cost of new equity would be
= 0.1428/(1-0.058) = 0.1516 i.e. 15.16%