Problem 10-13 Cost of Common Equity with Flotation Ballack Co.’s common stock cu

Question

Problem 10-13 Cost of Common Equity with Flotation

Ballack Co.’s common stock currently sells for $44.75 per share. The growth rate is a constant 11.2%, and the company has an expected dividend yield of 3%. The expected long-run dividend payout ratio is 30%, and the expected return on equity (ROE) is 16%. New stock can be sold to the public at the current price, but a flotation cost of 15% would be incurred. What would be the cost of new equity? Round your answer to two decimal places. %

Hint: Answer is NOT 46.51%

Explanation / Answer

P0 = $44.75

Dividend Yield = 3%

D1 = 3% * 44.75 =$1.3425

g = ROE * Retention Ratio = 16% * (1 - 30% ) = 16% * 70% = 11.2%

Floatation cost = 15%

Cost of equity = D1/P0(1 - F) + g = 1.3425/44.75(1 - 15%) + 11.2%

                                                     = 3.53% + 11.2% = 14.73%

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