chapter 10 4. Cost of Common Equity with and without Flotation The Evanec Compan
ID: 2642828 • Letter: C
Question
chapter 10
4. Cost of Common Equity with and without Flotation
The Evanec Company's next expected dividend, D1, is $3.15; its growth rate is 4%; and its common stock now sells for $30. New stock (external equity) can be sold to net $28.50 per share.
a. What is Evanec's cost of retained earnings, rs? Round your answer to two decimal places.
rs = %
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, re? Round your answer to two decimal places.
re = %
Explanation / Answer
a)
rs = D1 / P0 + g = ($3.15 / $30 ) + 0.04 = 0.145 = 14.5 %
Cost of retained earnings wll be based on the current value of $30 per share, as retained earnings are that portion of the profit attributable to the shareholders which has not been distributed as dividend. Hence using retained earnings as a source of capital does not require te company to pay any issue cost like floatation cost.
b)
Current Value of share = $30
Sale proceeds from share net of floatation cost = $28.50
Floatation Cost = $ 30 - $28.50 = $1.50
Therefore, F = floatation cost per share / current value per share = $1.50 / $30 = 0.05 = 5 %
c) The cost of new common stock, by issuing which the company will be raising new capital, will be based on the net proceeds from issue of share that is on $28.50.
Hence cost of new common stock, rs = D1 / P0 + g = $3.15 / $28.50 + 0.04 = 0.15 = 15% (rounded off to two decimal place)
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