Jarett & Sons\'s common stock currently trades at $28.00 a share. It is expected

Question

Jarett & Sons's common stock currently trades at $28.00 a share. It is expected to pay an annual dividend of $2.25 a share at the end of the year (D1 = $2.25), and the constant growth rate is 4% a year.

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

If the company issued new stock, it would incur a 19% flotation cost. What would be the cost of equity from new stock? Round your answer to two decimal places. Do not round your intermediate calculations.

Explanation / Answer

Dividend growth model

MPS = D1/(ke-g)

28 = 2.25/(Ke - 4%)

Ke - 0.04 = 2.25/28

Ke = 0.04 + 0.08

Ke = 12%

Cost of equity from new stock if flotation costs are 19%

Ke = [Dividend / Price * (1- floatation costs)] + growth rate

Ke = [2.25 / 28 ( 1 - 19%)] + Growth rate

Ke = (2.25 / 22.68) + 0.04

Ke = 0.099 + 0.04

Ke = 0.14 = 14%

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