If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock (re) is equal to 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). If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.

Question

Quizplus · Accepted Answer

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

If the Expected Dividend Growth Rate Is Zero, Then the Cost