Question

COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION

The Evanec Company's next expected dividend, D1, is $3.96; its growth rate is 4%; and its common stock now sells for $37. New stock (external equity) can be sold to net $31.45 per share.

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

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

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

Answer 1

COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION COST

Details Provided in the Question:

• Next year`s Dividend (D₁) = $3.96
• Price of Common Stock (P₀) = $37
• Price of New Common Stock = $31.45
• Growth Rate = 4% or 0.04
• Flotation Cost = 0 (Nil)

A. What is Evanec`s cost of retained earnings?

Cost of Retained Earnings (r_s) = D₁ / Price + g

                                                     = $3.96 / $37 + 0.04

                                                     = 0.10702 + 0.04

                                                    = 0.14702 or 14.70 %

Note:

• D₁ = Next year`s dividend
• Price = Price of common stock
• g = Growth Rate

B. What is Evanec`s percentage Flotation Cost?

Since, there is no flotation cost given in the question, we assume floatation cost to be the difference between cost of new common stock and cost of retained earnings.

Hence,

Flotation Cost = Cost of New Common Stock – Cost of Retained Earnings

                          = 16.59% - 14.70%

                          = 1.89%

C. What is Evanec`s cost of new common stock?

Cost of New Common Stock (re) = D₁ / Price x (1-F) + g

                                                           = $3.96 / $31.45 x (1-0) + 0.04

                                                           = 0.12591 + 0.04

                                                           = 0.16591 or 16.59%

Note:

• D₁ = Next year`s dividend
• Price = Price of common stock
• g = Growth Rate
• F = Flotation cost