Answer:
The cost of retained earnings is 11.84%
Step-by-step explanation:
The discounted cash flow approach or dividend discount model is used to calculate the fair value of the stock based on the present value of the expected future dividends (cash flows) from the stock. The formula to calculate the value of the stock today is,
P0 = D0 * (1+g) / (r - g)
Where,
- D0 is the dividend today or the last dividend paid
- g is the growth rate in dividends
- r is the cost of equity or retained earnings
As we already know the D0, P0 and the growth rate in dividends, we can calculate the value of r or the cost of equity by putting in the available values for D0, P0 and g in the formula and solve it.
22.5 = 0.8 * (1+0.08) / (r - 0.08)
22.5 * (r - 0.08) = 0.864
22.5r - 1.8 = 0.864
22.5r = 0.864 + 1.8
r = 2.664 / 22.5
r = 0.1184 or 11.84%