Question

Edna Recording Studios, Inc., reported earnings available to common stock of $4,200,000 last year. From those earnings, the com­pany paid a dividend of $1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 40% debt, 10% preferred stock, and 50% common stock. It is taxed at a rate of 40%. If the market price of the common stock is $40 and divendends are expected to grow at a rate of 6% per year for the forseeable future, what is the company's cost of retained earnings financing?

Answer 1

Cost of retained earnings

= Do(1 + g) + g

Po

= $1.26(1 + 0.06) + 0.06

$40

= 0.0333 + 0.06

= 0.0933 = 9.33%

Step-by-step explanation:

Cost of retained earnings is equal to current dividend paid subject to growth rate divided by the current market price of common stock plus growth rate