Byron Corporation
Byron Corporation's present capital structure, which is also its target capital structure, is 40 percent debt and 60 percent common equity. Next year's net income is projected to be $21,000, and Byron's payout ratio is 30 percent. The company's earnings and dividends are growing at a constant rate of 5 percent; the last dividend (D0) was $2.00; and the current equilibrium stock price is $21.88. Byron can raise all the debt financing it needs at 14.0 percent. If Byron issues new common stock, a 20 percent flotation cost will be incurred. The firm's marginal tax rate is 40 percent.
-Refer to Byron Corporation.What is the component cost of the equity raised by selling new common stock?

Question

Quizplus · Accepted Answer

The component cost of the equity raised by selling new common stock can be calculated using the dividend growth model as follows: $P_0 = \frac{D_0 \times (1 + g)}{r - g}$, where $P_0$ is the current stock price, $D_0$ is the last dividend, $g$ is the growth rate, and $r$ is the cost of equity. Given $D_0 = $2.00$, $g = 5\%$, and $P_0 = $21.88$, we first adjust $P_0$ for flotation costs: $P_0(1 - 0.20) = $21.88 \times 0.80 = $17.504$. Then, solving for $r$ gives us $r = \frac{D_0 \times (1 + g)}{P_0} + g = \frac{2.00 \times (1 + 0.05)}{17.504} + 0.05 = 0.17$ or 17%.

Byron Corporation Byron Corporation's Present Capital Structure, Which Is Also Its Target