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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

COST OF COMMON EQUITY WITH FLOTATION Ballack Co.’s common stock currently sells for $46 75 per share. The growth rate is a constant 12%, and the company has an expected dividend yield of 5%. The expected long-run dividend payout ratio is 25%, 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 5% would be incurred. What would be the cost of new equity?

Summary Introduction

To determine: The cost of equity from new stock.

Cost of Equity:

It is the cost of the company, while raising finance by issuing equity. It is earnings from the investment to the firm’s equity investors. It is the return to the stockholder holders’ equity investments. The issue of new stock incurs the flotation cost.

Explanation

Given,

Expected dividend, D1 is $2.3375 (working note).

Current market price P0 is $46.75 per share.

Growth rate is 12% or 0.12.

Flotation cost is 5% or 0.05.

The formula to calculate cost of the equity is,

r=D1P0(1F)+g

Where,

  • D1 is next expected divided.
  • P0 is the current market price.
  • g is the growth rate.
  • F is the flotation cost.

Substitute $2.3375 for D1, $46.75 for P0, 0.12 for g and 0.05 for F.

r=$2.3375$46.75(10.05)+0

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