Rivoli Inc. hired you as a consultant to help estimate its cost of capital. You have been provided with the following data: D0 = $0.80; P0 = $22.50; and g = 8.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?
A) 10.69%
B) 11.25%
C) 11.84%
D) 12.43%
E) 13.05%

Question

Quizplus · Accepted Answer

First, we calculate the dividend yield:
Dividend yield = D0/P0 = 0.80/22.50 = 0.0356 or 3.56%
Next, we calculate the expected growth rate using the constant growth model:
g = 8.00%
Finally, we use the CAPM formula to calculate the cost of equity from retained earnings:
Cost of equity from retained earnings = RFR + β*(Rm - RFR)
Assuming a risk-free rate of 3% and a market risk premium of 6%, we get:
Cost of equity from retained earnings = 3% + 1.0*(6%) = 9%
Adding the expected growth rate of 8%, we get:
Cost of equity from retained earnings = 9% + 8% = 11%
Therefore, the answer is C, 11.84%.