Question

Cost of common equity with and without flotation the evanec company’s next expected dividend, d 1 , is $3.18; its growth rate is 6%; and its common stock now sells for $36.00. new stock (external equity) can be sold to net $32.40 per share. what is evanec’s cost of retained earnings, r s ? what is evanec’s percentage flotation cost, f? what is evanec’s cost of new common stock, r e ?

Answer 1

The cost of retained earnings for Evanec Company is 14.83%. The percentage flotation cost is 10%. The cost of new common stock, taking into account the flotation costs, is 15.81%.

Step-by-step explanation:

The cost of common equity (retained earnings), rs, for Evanec Company can be calculated using the Gordon Growth Model, which is rs = (D1 / P0) + g, where D1 is the next expected dividend, P0 is the current stock price, and g is the growth rate. Using the given values, we find that rs = ($3.18 / $36.00) + 0.06 = 0.0883 + 0.06 = 0.1483, or 14.83%.

The percentage flotation cost, f, is the cost associated with issuing new stocks, which can be calculated as f = (P0 - Pnet) / P0, where Pnet is the net proceeds from selling the new stock. Therefore, f = ($36.00 - $32.40) / $36.00 = 0.10, or 10%.

The firm's cost of new common stock, re, takes into account the flotation cost, and is calculated as re = (D1 / Pnet) + g = ($3.18 / $32.40) + 0.06 = 0.0981 + 0.06 = 0.1581, or 15.81%.