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?
A) 5.06 percent
B) 5.50 percent
C) 10.00 percent
D) 10.56 percent

Question

Quizplus · Accepted Answer

The flotation-adjusted cost of equity can be calculated using the formula: $ \text{Cost of Equity} = \frac{D_1}{P_0(1 - F)} + g $, where $D_1$ is the next annual dividend, $P_0$ is the current share price, $F$ is the flotation cost as a decimal, and $g$ is the growth rate of dividends. Plugging in the values: $ \text{Cost of Equity} = \frac{1}{20(1 - 0.1)} + 0.05 = \frac{1}{18} + 0.05 = 0.0556 + 0.05 = 0.1056 $ or 10.56 percent.

Suppose That Tan Lines' Common Shares Sell for $20 Per