The Cost of Capital: Cost of New Common Stock The difference between the flotati

Question

The Cost of Capital: Cost of New Common Stock

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 $2.20 and it expects dividends to grow at a constant rate g = 4.7%. The firm's current common stock price, P0, is $20.70. 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

D1 =$ 2.2

P0= $20.7

g = 4.7%

Cost of Equity, Ke = D1/P0 + g = 2.2/20.7 + 4.7% = 10.62% + 4.7% = 15.32%

Cost of Equity with out floation cost adjustment = 12%

Cost of Equity with flotation cost adjustment = D1/P0(1-f) + g = 2.2/20.7(1-4.2%) + 4.7% = 15.79%

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