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Q) The CEO of the Geurts Corporation wants to know what its Cost of Retained Earnings...

Q) The CEO of the Geurts Corporation wants to know what its Cost of Retained Earnings is, when there is the following information:

Rd = 4%

Risk Premium of Rd = 4%

Rf = 3.5%

Market Risk Premium = 4.5%

Beta = 0.8

Last Dividend = $1.80

Growth Rate = 4%

Current Stock Price = $40

a. 7.87%

b. 7.79%

c. 7.93%

d. 7.73%

e. 8.02%

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Answer #1
Discounted cash flow approach
Ks = D1/P0 + g
(1.8*(1.04))/40 + 0.04
0.035 + 0.80*(0.045)
0.0868
CAPM Approach
Ke = Rf + Beta(Rm - Rf)
Ke = 0.035 + 0.80(0.045)
0.071
Bond yield plus premium approach
Ke = 0.04 + 0.04
Ke = 0.08
Average of the above 3 cost of retained earnings = (0.0868+0.071+0.08)/3
7.93%
Therefore, the cost of retained earnings is 7.93%
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