Royal Mediterranean Cruise Line's common stock is selling for $22 per share.The last dividend was $1.20,and dividends are expected to grow at a 6% annual rate.Flotation costs on new stock sales are 5% of the selling price.What is the cost of Royal's retained earnings?

Question

Quizplus · Accepted Answer

The cost of retained earnings is the rate at which the firm could sell new stock and use the proceeds to pay a dividend. The cost of new stock is the flotation cost plus the dividend yield. The flotation cost is 5% of the selling price, or 0.05 * $22 = $1.10. The dividend yield is the last dividend divided by the selling price, or $1.20 / $22 = 0.0545. The cost of new stock is therefore 0.0545 + 0.05 = 0.1045, or 10.45%. The cost of retained earnings is therefore 11.78%.

Royal Mediterranean Cruise Line's Common Stock Is Selling for $22