Question

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 what?

Answer 1

Answer:

0.19625 or 19.63%

Explanation:

Cost of retained earnings, r:

$=\frac{D0\times(1+g)}{P0}+g$

where,

D0 = Dividend paid yesterday

g = Expected growth rate of dividend

P0 = Current price of common stock

$=\frac{3.50\times(1+0.1)}{40}+0.1$

$=\frac{3.85}{40}+0.1$

      = 0.09625 + 0.1

      = 0.19625 or 19.63%