If a firm plans to issue new stock, flotation costs (investment bankers’ fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project’s expected return is reduced so it may not meet the firm’s hurdle rate for acceptance of the project. The second approach involves adjusting the cost of common equity as follows:
The difference between the flotation-adjusted cost of equity and the cost of equity calculated without the flotation adjustment represents the flotation cost adjustment.
Quantitative Problem: Barton Industries expects next year’s annual dividend, D1, to be $2.50 and it expects dividends to grow at a constant rate gL = 5.0%. The firm’s current common stock price, P0, is $25.00. If it needs to issue new common stock, the firm will encounter a 4.4% flotation cost, F. Assume that the cost of equity calculated without the flotation adjustment is 15.0% and the cost of old common equity is 14.3%. What is the flotation cost adjustment that must be added to its cost of retained earnings? Do not round intermediate calculations. Round your answer to two decimal places.
What is the cost of new common equity considering the estimate made from the three estimation methodologies? Do not round intermediate calculations. Round your answer to two decimal places.
Intrinsic Price per Share Based on FCFs
Blunderbluss Manufacturing’s balance sheets report $255 million in total debt, $60 million in short-term investments, and $45 million in preferred stock. Blunderbluss has 20 million shares of common stock outstanding. A financial analyst estimated that Blunderbuss’s value of operations is $830 million. What is the analyst’s estimate of the intrinsic stock price per share? Round your answer to the nearest cent.
Constant Dividend Growth Rate, gL
Muller’s Investigative Services has stock is trading at $65 per share. The stock is expected to have a year-end dividend of $3 per share (D1= $3), and it is expected to grow at some constant rate, gL, throughout time. The stock’s required rate of return is 11% (assume the market is in equilibrium with the required return equal to the expected return). What is your forecast of gL? Do not round intermediate calculations. Round the answer to two decimal places.
Assume that the average firm in C&J Corporation’s industry is expected to grow at a constant rate of 4% and that its dividend yield is 6%. C&J is about as risky as the average firm in the industry and just paid a dividend (D0) of $2.25. Analysts expect that the growth rate of dividends will be 50% during the first year (g0,1 = 50%) and 25% during the second year (g1,2 = 25%). After Year 2, dividend growth will be constant at 4%. What is the required rate of return on C&J’s stock? What is the estimated intrinsic price per share? Do not round intermediate calculations. Round the monetary value to the nearest cent and percentage value to the nearest whole number.