Quantitative Problem: Barton Industries expects next year\'s annual dividend, D1
ID: 2742418 • Letter: Q
Question
Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $2.20 and it expects dividends to grow at a constant rate g = 4%. The firm's current common stock price, P0, is $20.10. If it needs to issue new common stock, the firm will encounter a 5.3% 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
The cost of new common equity:-
= Expected Dividend / Price of common stock + Growth rate
= 2.20 / 19.0347(NOTE 1) + 0.04
= 0.1156 + 0.04
= 0.1556 i.e., 15.56 %
(NOTE 1):- The Price of stock = Current stock price - Flotation costs
= 20.10 - 5.3 % of 20.10
= 20.10 - 1.0653
= $ 19.0347
The flotation cost adjustment that must be added to its cost of retained earnings = 15.56 - 11.50 = 4.06 %.
Conclusion:-
1) The cost of new common equity = 15.56 %.
2) The flotation cost adjustment that must be added to its cost of retained earnings = 4.06 %. (approx)