Question

Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity.  The current market price of the firm’s stock is P0 = $59.2; its last dividend was D0 = $4.7, and its expected dividend growth rate is 5.3 percent.  What will Allison’s marginal cost of retained earnings, rs, be?

Answer 1

Answer: Retained earning- It is the amount of net profit that is retained for further expansion purpose, it is not distributed to the shareholders in the form of dividend.

From Gordon growth model-

Cost of Retained earnings (Re) = (Upcoming year's dividend / Stock price) + growth rate

Upcoming dividend = Last dividend (D0) * (1+growth rate)

Given values: Last dividend (D0) = $4.7, Stoc price (P0) = $59.2, Growth (g) = 5.3%

Upcoming dividend: 4.7 * (1.053) = 4.9491

Re = (4.9491 / 59.2) + .053

Re = 13.66%