Barton Industries expects next year\'s annual dividend, D_1, to be $2.30 and it
ID: 2743332 • Letter: B
Question
Barton Industries expects next year's annual dividend, D_1, to be $2.30 and it expects dividends to grow at a constant rate g = 4.2%. The firm's current common stock price, P_0, is $21.10. If it needs to issue new common stock, the firm will encounter a 5% 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%. What is the flotation cost adjustment that must be added to its cost of retained earnings? Round your answer to 2 decimal places. Do not round intermediate calculations. % What is the cost of new common equity considering the estimate made from the three estimation methodologies? Round your answer to 2 decimal places. Do not round intermediate calculations. %Explanation / Answer
Answer
Answer 1
Cost of retained earnings = (Dividend for next year / Current stock Price) + Growth rate
= (2.30 / 21.10) + 0.042
= 0.109 + 0.042
= 0.151
= 15.1%
Cost of new equity = (Dividend for next year / Current stock Price – Floatation cost) + Growth rate
= [2.30 / 21.10 – (21.10 *0.05)] + 0.042
= [2.30 / 21.10 – 1.055] + 0.042
= [2.30 / 20.045] + 0.042
= 0.1147 + 0.042
= 0.1567
=15.67%
Floatation Cost Adjustment = Cost of New Equity – Cost of Retained earnings
= 15.67% - 15.1%
= 0.57%
Answer 2
Cost of new equity = (Dividend for next year / Current stock Price – Floatation cost) + Growth rate
= [2.30 / 21.10 – (21.10 *0.05)] + 0.042
= [2.30 / 21.10 – 1.055] + 0.042
= [2.30 / 20.045] + 0.042
= 0.1147 + 0.042
= 0.1567
=15.67%
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