Question

Retained earnings versus new common stock   Using the data for a firm shown in the following​ table, calculate the cost of retained earnings and the cost of new common stock using the​ constant-growth valuation model.

Current market price per share

Dividend growth rate

Projected dividend per share next year

Underpricing per share

Flotation cost per share

​$60.00

77​%

​$1.80

​$2.00

​$2.00

a The cost of retained earnings is? ​(Round to two decimal​ places.)

b.  The cost of new common stock is Round to two decimal​ places.)

Answer 1

Given,

Current price = $60

Dividend growth rate (g) = 77% or 0.77

Projected dividend = $1.80

Under pricing = $2

Flotation cost = $2

Solution :-

(a)

Cost of retained earnings = (projected dividend current price) + g

= ($1.80 $60) + 0.77

= 0.03 + 0.77 = 0.80 or 80.00%

(b)

Cost of new common stock = [projected dividend (current price - under pricing - flotation cost)] + g

= [$1.80 ($60 - $2 - $2)] + 0.77

= [$1.80 $56] + 0.77

= 0.0321 + 0.77 = 0.8021 or 80.21%