Javits & Son's common stock currently trades at $30.00 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 5% a year. a) What is the company's cost of common equity if all of its equity comes from retained earning? b) If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?

The answers are stated below

Explanation:

Current Share Value (P0) = $30

Expected annual dividend per share (D1) = $3

Constant Growth rate (g) = 5% a year

(a) What is the Company's Cost of Common Equity if all of its equity comes from retained earnings?

Cost of Common Equity (R) = [D1 / P0] + g

Cost of Common Equity (R) = [$3 / $30] + 0.05

Cost of Common Equity (R) = 0.15 (or) 15%

Cost of Common Equity (R) = 15%

(b) If the Company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?

Cost of equity from new stock (R) = [D1 / P0 (1-flotation Cost) ] + g

Cost of equity from new stock (R) = [$3 / $30 (1-0.10) ] + 0.05

Cost of equity from new stock (R) = [$3 / $30 (0.9) ] + 0.05

Cost of equity from new stock (R) = [$3 / $27] + 0.05

Cost of equity from new stock (R) = 0.1611 (or) 16.11%

Cost of equity from new stock (R) = 16.11%