Rivoli Inc.hired you as a consultant to help estimate its cost of common equity.You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% Based on the DCF approach, what is the cost of common from retained earnings?

Question

Quizplus · Accepted Answer

Using the DCF approach, the cost of common equity from retained earnings can be calculated as follows:

Cost of common equity (r) = (D1/P0) + g

Where:
D1 = D0 x (1 + g)
D0 = last year's dividends = $0.8
P0 = current stock price = $22.50
g = growth rate = 8.00%

D1 = $0.8 x (1 + 0.08) = $0.864

r = ($0.864/$22.50) + 0.08 = 0.0384 + 0.08 = 0.1184 or 11.84%

Therefore, the best choice is C.