Question

brookes corporation has an expected dividend (D₁) of $1.60, a current stock price (P₀) of $40, and a constant growth rate of 6.7%. if new common stock is issued, the company will incur flotation costs of 6%. what is the company's cost of retained earnings?

Answer 1

The cost of retained earnings for Brookes Corporation, calculated using the Gordon Growth Model, is 10.7%, ignoring the flotation costs of issuing new common stock.

Step-by-step explanation:

The student is interested in the cost of retained earnings for Brookes Corporation, which requires an understanding of the Gordon Growth Model to calculate this. Using the provided information of a dividend (D1) of $1.60, a stock price (P0) of $40, and a constant growth rate of 6.7%, we can employ the formula for the cost of retained earnings (ke):

ke = (D1 / P0) + g

Where D1 is the expected dividend, P0 is the current stock price, and g is the growth rate. As hinted by the question, flotation costs refer to the costs incurred when new stock is issued, which do not affect the cost of retained earnings. Hence, they are not included in this calculation.

By placing the given values into this formula, we can calculate the cost of retained earnings as follows:

ke = ($1.60 / $40) + 6.7%

ke = 4% + 6.7%

ke = 10.7%

Thus, the cost of retained earnings for Brookes Corporation is 10.7%.