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?
To calculate Evanec's cost of retained earnings, r_s, we can use the Dividend Growth Model. The formula for the cost of retained earnings can be represented as:
r_s = (D_1 / P_0) + g
where:
D_1 is the expected dividend next year ($3.18),
P_0 is the current stock price ($36.00), and
g is the growth rate (6%).
Plugging in the given values:
r_s = (3.18 / 36) + 0.06
r_s = 0.08833 + 0.06
r_s = 0.14833 or 14.833%
Therefore, Evanec's cost of retained earnings, r_s, is approximately 14.833%.
Now let's calculate Evanec's percentage flotation cost, F. Flotation cost refers to the cost incurred in issuing new securities. It is typically represented as a percentage of the issue price.
We are given that new stock (external equity) can be sold to net $32.40 per share. The flotation cost is the difference between the net selling price and the issue price, expressed as a percentage of the issue price.
F = [(P_0 - Net Selling Price) / P_0] × 100
Plugging in the given values:
F = [(36 - 32.40) / 36] × 100
F = (3.60 / 36) × 100
F = 0.1 × 100
F = 10%
Therefore, Evanec's percentage flotation cost, F, is 10%.
Finally, to calculate Evanec's cost of new common stock, r_e, we can use the formula:
r_e = (D_1 / (P_0 - F)) + g
Plugging in the known values:
r_e = (3.18 / (36 - 10)) + 0.06
r_e = 0.10215 + 0.06
r_e = 0.16215 or 16.215%
Therefore, Evanec's cost of new common stock, r_e, is approximately 16.215%.