Overland paid a dividend of $3 last year and its stock is selling at $75 per share. A constant growth rate of 5% is expected. Overland's flotation costs for a new issue are 10% and the marginal tax rate is 40%. Calculate the cost of retained earnings.

Question

Quizplus · Accepted Answer

The formula for cost of retained earnings is:
Cost of retained earnings = (Dividend / Net issuing price) + Growth rate
Net issuing price = (1 - Flotation cost) * Market price per share

Dividend = $3
Market price per share = $75
Flotation cost = 10% = 0.1
Net issuing price = (1 - 0.1) * 75 = $67.5
Growth rate = 5%

Cost of retained earnings = (3 / 67.5) + 0.05 = 0.092 or 9.2% (rounded to one decimal place)

Therefore, the best choice is C.

Overland Paid a Dividend of $3 Last Year and Its