Barton Industries expects next year's annual dividend, D1, to be $2.30 and it expects dividends...

Question:

Barton Industries expects next year's annual dividend, D1, to be $2.30 and it expects dividends to grow at a constant rate g = 4.6%. The firm's current common stock price, P0, is $20.50. If it needs to issue new common stock, the firm will encounter a 4.9% 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%.

a. What is the flotation cost adjustment that must be added to its cost of retained earnings?

b. What is the cost of new common equity considering the estimate made from the three estimation methodologies?

Cost Of Equity:

The cost of equity is the required rate of return on equity investment. From the perspective of the shareholders, the cost of equity is their opportunity cost when investing in the firm.

Answer and Explanation:

Cost of equity without the flotation cost = 12%

Cost of equity with the flotation cost:

{eq}r_s = \displaystyle\frac{\$2.30}{\$20.50\times (1-4.9\%)} + 4.6\% = 16.40\% {/eq}

a. Flotation cost adjustment:

Flotation cost adjustment = 16.40% - 12% = 4.4%

b. Cost of new equity:

Cost of new equity = 11.5% + 4.4% = 15.90%


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