New Issue Common Stock Costs

Types of Financing Costs Descriptions of Financing Costs

Broker’s fee Finder’s and facilitator’s fees

Underwriting fees Assumption of issuance risk by the underwriter

(investment bank)

Closing costs Miscellaneous package of expenses related to closing

the deal

Professional fees Legal, tax, and accounting consulting fees

Miscellaneous expenses Costs of printing, recording, meetings, and so on

Below are the advantages and disadvantages of common stock financing to the firm.

Advantages Disadvantages

1. No interest or required dividends 1. Highest cost of capital

2. No covenants, restrictions, or preferences 2. Dilution of shareholders’ equity

position

3. Improved liquidity position 3. Highest issuance (flotation) cost

4. Market uncertainty at time of issue

Calculating New-Issue Equity Cost of Capital

The cost (kncs) to raise new common stock equity is calculated in the same way as the constant

growth model discussed for internal-equity financing but modified with a provision for issuance

costs:

kncs.= (D1/NPncs) + g

where:

NPncs = proceeds from the issue of new common stock minus issuance flotation

costs

kncs = new common stock after-tax cost of capital (not tax deductible)

D = last common stock dividend

D1 = next common stock dividend

g = steady-state growth rate for dividends

Close the Cycle—Back to the Weighted Average Cost of Capital

We have now determined one or more methods to compute the cost of capital for each of the

financing components of the firm’s weighted average cost of capital. The final step is to pull it all

together and calculate the firm’s weighted average cost of capital:

kwacc = wd(kd)(1 – Tc) + wps(kps) + wcs(kcs) + wncs(kncs)

where:

The debt component, kd =

The preferred stock component = kps = Dps/NPps

The internal common equity

component =

kcs = (D1/ NPcs) + g or

kcs = rrf + Bj(rm – rrf)

The external common equity

component =

kncs = (D1/ NPncs) + g