Question

Jarett & Sons's common stock currently trades at $22.00 a share. It is expected to pay an annual dividend of $3.00 a share at the end of the year (D1 = $3.00), and the constant growth rate is 4% a year.

a.What is the company's cost of common equity if all of its equity comes from retained earnings? Do not round intermediate calculations. Round your answer to two decimal places.

b.If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

a. The cost of common equity is computed as follows:

= (D1 / price) + growth rate

= ($ 3 / $ 22) + 4%

= 17.64%

b. The cost of equity is computed as follows:

= [ D1 / (Price x (1 - flotation cost) ] + growth rate

= [ $ 3 / ($ 22 x 0.90) ] + 4%

= ($ 3 / $ 19.8) + 4%

= 19.15%