Question

The Evanec Company's next expected dividend, D₁, is $3.05; its growth rate is 7%; and its common stock now sells for $39.00. New stock (external equity) can be sold to net $31.20 per share.

1. What is Evanec's cost of retained earnings, r_s? Do not round intermediate calculations. Round your answer to two decimal places.

   r_s = %

2. What is Evanec's percentage flotation cost, F? Round your answer to two decimal places.

   F = %

3. What is Evanec's cost of new common stock, r_e? Do not round intermediate calculations. Round your answer to two decimal places.

   r_e = %

Answer 1

i) Cost of retained earnings (Re) :

Price (Existing stock) = D1 / (Re - g)

Here,

D1 (Expected dividend) = $3.05

Price (Existing stock) = $39

Re (Cost of retained earnings) = ?

g (Growth rate) = 7% or 0.07

Now, put the values into formula

$39 = $3.05 / (Re - 0.07)

Re - 0.07 = $3.05 / $39

Re - 0.07 = 0.0782

Re = 0.0782 + 0.07

Re (Cost of retained earnings) = 0.1482 or 14.82%

ii) Flotation cost % :

Flotation cost % = (Existing stock price - New stock price) / Existing stock price * 100

Flotation cost % = ($39 - $31.20) / $39 * 100

Flotation cost % = $7.80 / $39 * 100

Flotation cost % = 20%

iii) Cost of new common stock (Ke) :

New price = D1 / (Ke - g)

Here,

New price = $31.20

Ke (Cost of new common stock) = ?

D1 (Exepected dividend) = $3.05

g (Growth rate) = 7% or 0.07

Now, put the values into formula

$31.20 = $3.05 / (Ke - 0.07)

Ke - 0.07 = $3.05 / $31.20

Ke - 0.07 = 0.0978

Ke = 0.0978 + 0.07

Ke = 0.1678 or 16.78%