4. Cost of external equity
Cost of newly issued stock (kc) is the cost of external equity, and it is based on the cost of retained earnings increased for flotation costs (cost of issuing common stock). For a constant-growth company, this can be calculated as follows:
kc= D1__ + g
Example: cost of newly issued stock
As in our previous example for Newco, assume the company's stock is selling for $40, its expected ROE is 10%, next year's dividend is $2 and the company expects to pay out 30% of its earnings. Additionally, assume the company has a flotation cost of 5%. What is Newco's cost of new equity?
kc = 2 + 0.07 = 0.123, or 12.3%
It is important to note that the cost of newly issued stock is higher than the company's cost of retained earnings. This is due to the flotation costs.
Target Capital Structure
InvestingA flotation cost is incurred when a company issues new securities.
Small BusinessCost of capital is the cost of funds used to finance a business.
InvestingCost accounting measures several different types of costs associated with a company’s production processes.
InvestingThe cost of equity is the rate of return an investor requires from a stock before exploring other opportunities.
Personal FinanceCost of funds is the interest cost financial institutions pay to use the funds they deploy in their business.
Managing WealthUnderstanding equity cost basis is critical for tracking the gains or losses of an investment.
InvestingThe cost of revenue is the total costs a business incurs to manufacture and deliver a product or service.
Small BusinessAn externality is a consequence of an economic activity that is experienced by unrelated third parties.
InvestingMarginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
InvestingIncremental cost is the added cost of manufacturing one more unit.