Problem 10-4 Cost of Equity with and without Flotation Jarett & Sons\'s common s

Question

Problem 10-4
Cost of Equity with and without Flotation

Jarett & Sons's common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of $1.25 a share at the end of the year (D1 = $1.25), and the constant growth rate is 8% a year.

What is the company's cost of common equity if all of its equity comes from retained earnings? Round your answer to two decimal places. Do not round your intermediate calculations.
____________%

If the company issued new stock, it would incur a 20% flotation cost. What would be the cost of equity from new stock? Round your answer to two decimal places. Do not round your intermediate calculations.
___________%

Explanation / Answer

price = dividend next year /(required rate of return - growth rate)

a)

30 = 1.25/r-8%

=>

cost of common equity r = 12.17%

b)

30 * (1-20%) = 1.25/r-8%

cost of common equity r = 13.21%

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