A firm pays its bondholders a 12% return. Its cost of retained earnings may be estimated by:

Question

Quizplus · Accepted Answer

The cost of retained earnings for a firm is typically higher than the cost of debt because equity investors demand a higher return for the increased risk they assume compared to bondholders. Adding three to five percentage points to the firm's cost of debt (12% in this case) is a simplified method to estimate the cost of retained earnings, acknowledging the higher risk and return expectation of equity investors.

A Firm Pays Its Bondholders a 12% Return