Question

Suppose that Tan Lines' common shares sell for $20 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 5 percent per year, indefinitely. If Tan Lines faces a flotation cost of 10 percent on new equity issues, what will be the flotation-adjusted cost of equity

Answer 1

Cost of equity = 10.6%

Step-by-step explanation:

According to the dividend valuation, the value of a stock is the present value of expected future dividends discounted at the required rate of return.

The model can me modified to determined the cost of equity having flotation cost as follows:

Cost of equity = D(1+r )/P(1-f) + g

d- dividend, p- price of stock , f - flotation cost , - g- growth rate in dividend

D-1.00, p - 20, f- 10%, g- 5%

Applying this to the question;

cost of equity - 1.00/(20×(1-0.1) )+ 0.05

= 10.6%

Cost of equity = 10.6%