. The difference between the flotation-adjusted cost of equity and the cost of e
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Question
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The difference between the flotation-adjusted cost of equity and the cost of equity calculated without the flotation adjustment represents the flotation cost adjustment.
Quantitative Problem: Barton Industries expects next year's annual dividend, D1, to be $2.00 and it expects dividends to grow at a constant rate g = 4%. The firm's current common stock price, P0, is $21.60. If it needs to issue new common stock, the firm will encounter a 4.2% 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
a. The cost of equity with floation costs is as shown below
The price of the stock is 21.60
Whith a 4.2% floation cost, the priuce of the cost is 21.60*(1-0.042)
Hence the cost of equity is given by D1/P0 + g = 2.00/21.60*(1-0.042) + 0.04
Cost of equity with floatation cost = 0.13665 = 13.67%
The Cost of retained earnings = 11.5%
Cost adjustment that must be added to its cost of retained earnings = 13.67% - 11.5% = 2.17%
b. So the cost of new equity is 13.67% (with floatation costs)
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