Johnson Production Company paid a dividend yesterday of $3.50 per share.The dividend is expected to grow at a constant rate of 10% per year.The price of KayCee's common stock today is $40 per share.If KayCee decides to issue new common stock,flotation costs will equal $4.00 per share.KayCee's marginal tax rate is 35%.Based on the above information,the cost of retained earnings is

Question

Quizplus · Accepted Answer

The cost of retained earnings (Kre) can be calculated using the Gordon Growth Model formula:

Kre = (D1 / P0) + g

where, 
D1 = expected dividend next year = $3.50 x (1 + 10%) = $3.85
P0 = current stock price = $40
g = growth rate of dividends = 10%

Kre = ($3.85 / $40) + 0.10 = 0.19625 or 19.63%

Therefore, the cost of retained earnings is 19.63%.

Johnson Production Company Paid a Dividend Yesterday of $3