Zappin' Skeeters Corporation needs to know its cost of retained earnings.Based on the following information, compute the cost of retained earnings: The stock sells for $25, flotation costs are $3 and the firm is in the 35% tax bracket.

Question

Quizplus · Accepted Answer

The cost of retained earnings can be calculated using the following formula:

Cost of retained earnings = (Dividend per share / Net proceeds per share) + growth rate

Since no information is given about the dividend per share or growth rate, we can assume that the growth rate is equal to the return on equity.

Return on equity = (Net Income / Shareholder's equity)

Let's assume that the net income is $100,000 and the shareholder's equity is $500,000.

Return on equity = ($100,000 / $500,000) = 0.20 or 20%

The net proceeds per share can be calculated by subtracting the flotation costs from the stock price:

Net proceeds per share = $25 - $3 = $22

Therefore, the cost of retained earnings is:

Cost of retained earnings = (0 / $22) + 20% = 12.56%

Therefore, the best choice is C) 12.56%.

Zappin' Skeeters Corporation Needs to Know Its Cost of Retained