Question

Banyan Co.’s common stock currently sells for $40.25 per share. The growth rate is a constant 4%, and the company has an expected dividend yield of 6%. The expected long-run dividend payout ratio is 50%, and the expected return on equity (ROE) is 8.0%. New stock can be sold to the public at the current price, but a flotation cost of 10% 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

Expected dividend yield = Expected Dividend / Current Stock price

6% = Expected Dividend / $40.25

Expected Dividend = $2.415

growth rate = (1 - Dividend payout ratio) * ROE

growth rate = (1 - 50%) * 8%

growth rate = 4%

Cost of new equity = (Expected Dividend / Current Stock price * (1 - flotation cost)) + growth rate

Cost of new equity = ($2.415 / $40.25 * (1 - 10%)) + 0.04

Cost of new equity = 10.67%