The Cost of Capital: Cost of New Common Stock

If a firm plans to issue new stock, flotation costs (investmentbankers' fees) should not be ignored. There are two approaches touse to account for flotation costs. The first approach is to addthe sum of flotation costs for the debt, preferred, and commonstock and add them to the initial investment cost. Because theinvestment cost is increased, the project's expected return isreduced so it may not meet the firm's hurdle rate for acceptance ofthe project. The second approach involves adjusting the cost ofcommon equity as follows:



The difference between the flotation-adjusted cost of equity andthe cost of equity calculated without the flotation adjustmentrepresents the flotation cost adjustment.

Quantitative Problem: Barton Industries expectsnext year's annual dividend, D₁, to be $2.50 and itexpects dividends to grow at a constant rate g = 4.8%. The firm'scurrent common stock price, P₀, is $23.00. If it needsto issue new common stock, the firm will encounter a 4.9% flotationcost, F. Assume that the cost of equity calculated without theflotation adjustment is 12% and the cost of old common equity is11.5%. What is the flotation cost adjustment that must be added toits cost of retained earnings? Round your answer to 2 decimalplaces. Do not round intermediate calculations.
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What is the cost of new common equity considering the estimatemade from the three estimation methodologies? Round your answer to2 decimal places. Do not round intermediate calculations.
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