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

0.19625 or 19.63%

Step-by-step explanation:

Cost of retained earnings, r:

`=(D0*(1+g))/(P0)+g`

where,

D0 = Dividend paid yesterday

g = Expected growth rate of dividend

P0 = Current price of common stock

`=(3.50*(1+0.1))/(40)+0.1`

`=(3.85)/(40)+0.1`

= 0.09625 + 0.1

= 0.19625 or 19.63%