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% on new equity issues, what will be the flotation-adjusted cost of equity?
A) 5.06%
B) 5.50%
C) 10.00%
D) 10.56%

Question

Quizplus · Accepted Answer

The formula for the flotation-adjusted cost of equity is:

Flotation-adjusted cost of equity = Cost of equity * (1 - Flotation cost percentage)

The cost of equity can be calculated using the dividend growth model:

Cost of equity = (Next year's dividend / Current share price) + Growth rate

Next year's dividend = $1.00 * 1.05 = $1.05
Current share price = $20
Growth rate = 5%

Cost of equity = ($1.05 / $20) + 5% = 10.25%

Flotation-adjusted cost of equity = 10.25% * (1 - 10%) = 9.23% ≈ 10.56%

Therefore, the best choice is D.

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