Cost of Common Equity with and without Flotation The Evanec Company\'s next expe
ID: 2733122 • Letter: C
Question
Cost of Common Equity with and without Flotation The Evanec Company's next expected dividend, D_1, is $2.69; its growth rate is 7%; and its common stock now sells for $31. New stock (external equity) can be sold to net $26.35 per share. a. What is Evanec's cost of retained earnings, r_s? Round your answer to two decimal places. r_s = 15.68 % b. What is Evanec's percentage flotation cost, F? Round your answer to two decimal places. F = % C. What is Evanec's cost of new common stock, F_s? Round your answer to two decimal places. F_s = %Explanation / Answer
Solution: Expected Dividend (D1) = $ 2.69 Growth Rate (g) = 7 % Price of Common Stcok = $ 31 Price of New Stock = $ 26.35 a. Cost of Ratained Earning P0 = D1 / Ke - g 31 = 2.69 / Ke- 0.07 Ke - 0.07 =2.69 / 31 Ke = 0.0868 + 0.7 = 0.1568 or 15.68 % Hence retained earning is 15.68% b. Floation cost Floation cost = price ofCurrent stock - price of new stock = 31-26.35 = 4.65 % of Floation Cost = Floation cost * 100 / price of current stock = 4.65 * 100 / 31 =15% c. cost of new common stock Cost of New Equity = D1 Price × (1 F) Where, D1 is dividend in next period Price is the issue price of a share of stock F is the ratio of flotation cost to the issue price Growth Rate is the dividend growth rate Cost of New Equity = 2.69 / (31 * (1-0.15) + 0.07 = 0.1021 + 0.07 = 0.1721 or 17.21 %