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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION The Evanec Company’s next expected dividend, D1 is $3.18; its growth rate is 6%; and its common stock now sells for $36.00. New stock (external equity) can be sold to net $32.40 per share.

  1. a. What is Evanec’s cost of retained earnings, rs?
  2. b. What is Evanec’s percentage flotation cost, F?
  3. c. c What is Evanec’s cost of new common stock, re?

a.

Summary Introduction

To determine: Cost of retained earnings.

Introduction:

Cost of Retained Earnings:

A company can raise its capital by issuing new shares or by retaining its current earnings. The retained earnings is assumed as free of cost generally but it is wrong because the cost of the retained earnings can be measured as per the opportunity cost principle. If the company has no retained earnings then the company issues new shares in which the shareholders earn the dividend. Thus, the loss of dividend can be considered as an opportunity cost of the retained earnings.

Explanation

Given information:

Next expected dividend is $3.18.

Growth rate is 6% or 0.06.

Current price of stock is $36.

The formula to calculate cost of retained earnings is,

r=D1P0+g

Where

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

b.

Summary Introduction

To determine: The percentage of flotation cost.

Introduction:

Flotation Cost:

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

c.

Summary Introduction

To determine: The cost of equity from the new stock.

Introduction:

Cost of Equity:

It is the cost of the company while raising finance by issuing equity. It is the earnings from an 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.

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