The cost of external equity capital raised by issuing new common stock (re) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (rs), divided by one minus the percentage flotation cost required to sell the new stock, (1 - F)."

Question

Quizplus · Accepted Answer

This statement is true only if the expected growth rate is zero. Here are some illustrative numbers that show that the statement is true if g = 0 but false otherwise.
 $\begin{array}{lrc}
& \text { Positive } \mathrm{g} & \text { Zero g } \
\text { Price } & \$ 10.00 & \$ 10.00 \
 \text { Dividend } & \$ 0.50 & \$ 0.50 \
 \text { Growth }  & 6.00 \% & 0.00 \% \
\text { Flotation }& 5.00 \% & 5.00 \% \
r_{\mathrm{s}}=\mathrm{D}_{1} / \mathrm{P}_{\mathrm{P}}+\mathrm{g} & 11.00 \% & 5.00 \% \
 \mathrm{P}_{\mathrm{O}}(1-\mathrm{F})+\mathrm{g} \mathrm{r}_{\mathrm{e}}=\mathrm{D}_{1} / & 11.263 \% & 5.263 \% \text { Equal only if } \mathrm{g}=\text { zero } \
\mathrm{r}_{\mathrm{S}} /(1-\mathrm{F}) & 11.579 \% & 5.263 \%
\end{array}$

The Cost of External Equity Capital Raised by Issuing New