A firm's dividend growth rate is 3.2% when the dividend payout ratio equals 37%. It is expected to pay a dividend of $2.2 next year. If the cost of external equity for the firm equals 19.2% and the firm's stock is currently priced at $14.1, the flotation cost of equity equals ________.
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A. B. C. D.Explanation
IF F is the percentage flotation cost and P is the amount of new equity raised per new share, then Ke = D1/[P(1-F)] + g, where Ke is the cost of external equity.
Here, g = 3.2%, D1 = $2.2, P = $14.1 and Ke = 19.2%. Therefore, 19.2% = 2.2/(14.1*(1-F)) + 3.2%. Solving for F gives F = 2.5%.