Javits & Sons\' common stock currently trades at $30 a share. It is expected to

Question

Javits & Sons' common stock currently trades at $30 a share. It is expected to pay an annual dividend of $1.50 a share at the end of the year (D1 = $1.50), and the constant growth rate is 7% a year.

a. What is the company's cost of common equity if all of its equity comes from retained earnings. Round your answer to two decimal places.
________%

b. If the company were to issue new stock, it would incur a 11% flotation cost. What would the cost of equity from new stock be? Round your answer to two decimal places.
___________%

Explanation / Answer

According to the given problem, Current price of the share = $30 Annual dividend per share = $1.50 Constant growth rate = 7% a) According to Dividend growth model, Cost of equity (Re) = (D1 / P0) + g where D1 is the annual dividend per share P0 is the current price per share g is the growth rate. Substituting the values in the above formula, we get Cost of equity (Re) = ($1.50 / $30) + 0.07 = 0.05 + 0.07 = 0.12 or 12% Therefore, the cost of equity is 12% b) Calculating the cost of equity using flotation costs: According to the given problem, the flotation costs will be 11% on the issue of new stock. After deducting the flotation cost, the price of the share would be Price of the share = $30 -11% ($30) = $30 - $3.3 = $26.7 Therefore, the price of the share would be $26.7 on the issue of new stock after deducting the flotation costs. Cost of equity (Re) = ($1.50 / $26.7) + 0.07 = 0.056 + 0.07 = 0.126 or 12.6% Therefore, the cost of equity is 12.6% = 0.056 + 0.07 = 0.126 or 12.6% Therefore, the cost of equity is 12.6%

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