Question

Banyan Co.’s common stock currently sells for $48.25 per share. The growth rate is a constant 4%, and the company has an expected dividend yield of 4%. The expected long-run dividend payout ratio is 35%, and the expected return on equity (ROE) is 7%. New stock can be sold to the public at the current price, but a flotation cost of 15% would be incurred. What would be the cost of new equity? Do not round intermediate calculations. Round your answer to two decimal places.

  %

Answer 1

Calculation of Cost of New Equity :

Cost of New Equity = [Expected Dividend / (Stock Price - Flotation Cost)] + Growth Rate

Calculation of Expected Dividend :

Dividend Yield = Expected Dividend / Current Price

==> Expected Dividend = 0.04 * 48.25

= 1.93

Growth Rate = 4% (Since growth rate have been given we do not consider Payout ratio and Return on Equity)

Flotation Cost = 48.25 * 15% = 7.2375

Cost of New Equity = [1.93 / (48.25 - 7.2375)] + 0.04

= 0.0871 or 8.71%