Problem 10-7. Cost of common equity with and without flotation The Evanec Compan

Question

Problem 10-7. Cost of common equity with and without flotation

The Evanec Company's next expected dividend, D1, is $3.25; its growth rate is 5%; and its common stock now sells for $32. New stock (external equity) can be sold to net $27.20 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

D1 = 3.25
g = 5%
P = 32
New stock = 27.2

a.
P = D1/(r-g)
cost of retained earnings r = D1/P + g
= 3.25/32 + 5%
= 15.15625%
= 15.16% (rounded to 2 decimals)

b.
New Stock price = Existing Stock price * (1-floatation cost)
Floatation cost = 1 - (new stock price/existing stock price)
= 1 - (27.2/32)
= 15%

c.
Cost of new common stock = cost of retained earnings/(1-floatation cost)
= 15.16%/(1-15%)
= 17.83529%
= 17.84 (rounded to 2 decimals)

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