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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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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 $1.00 a share at the end of the year [D1 = $1.00], and the constant growth rate is 4% a year.

  1. a. What is the company’s cost of common equity if all of its equity comes from retained earnings?
  2. b. If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?

a.

Summary Introduction

To identify: The cost of common equity of the company if all of its equity comes from retained earnings.

Introduction:

Cost of Equity:

It is the cost of the company while raising finance by issuing equity. It is the earnings from the investment to the firm’s equity investors. It is the return to the stockholders investments.

Explanation

Given information:

Next expected dividend is $1.

Current market price is $30.

The rate of constant growth is 4% 0r 0.04.

The formula to calculate cost of common equity is,

r=D1P0+g

Where

  • r is the cost of equity.
  • D1 is the next expected dividend.
  • P0 is the current price of the stock

b.

Summary Introduction

To determine: The cost of equity from new stock if 10% floatation cost is incurred while issuing new stock.

Introduction:

Cost of New Stock:

This is the cost of issuing fresh share to raise capital. Company can raise capital by retaining its earning and by issuing the new shares. The issue of new share incurs floatation cost.

Flotation Cost:

The cost which occurs when the new shares are issued by the company is called floatation cost. It increases the cost of newly issued shares.

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