Question

Problem 11-17 Costs of retained earnings and new common stock [LO11-3] Compute Ke and Kn under the following circumstances: a. D1 = $7.00, P0 = $78, g = 4%, F = $3.00. (Do not round intermediate calculations. Round your answers to 2 decimal places.) b. D1 = $0.40, P0 = $38, g = 5%, F = $2.00. (Do not round intermediate calculations. Round your answers to 2 decimal places.) c. E1 (earnings at the end of period one) = $6, payout ratio equals 30 percent, P0 = $42, g = 10.0%, F = $3.50. (Do not round intermediate calculations. Round your answers to 2 decimal places.) d. D0 (dividend at the beginning of the first period) = $4, growth rate for dividends and earnings (g) = 5%, P0 = $68, F = $5.

Answer 1

Answer a.

Cost of Retained Earnings, Ke = D1 / P0 + g
Cost of Retained Earnings, Ke = $7.00 / $78.00 + 0.04
Cost of Retained Earnings, Ke = 0.1297 or 12.97%

Cost of New Common Stock, Kn = D1 / [P0 - F] + g
Cost of New Common Stock, Kn = $7.00 / [$78.00 - $3.00] + 0.04
Cost of New Common Stock, Kn = $7.00 / $75.00 + 0.04
Cost of New Common Stock, Kn = 0.1333 or 13.33%

Answer b.

Cost of Retained Earnings, Ke = D1 / P0 + g
Cost of Retained Earnings, Ke = $0.40 / $38.00 + 0.05
Cost of Retained Earnings, Ke = 0.0605 or 6.05%

Cost of New Common Stock, Kn = D1 / [P0 - F] + g
Cost of New Common Stock, Kn = $0.40 / [$38.00 - $2.00] + 0.05
Cost of New Common Stock, Kn = $0.40 / $36.00 + 0.05
Cost of New Common Stock, Kn = 0.0611 or 6.11%

Answer c.

D1 = E1 * Payout Ratio
D1 = $6.00 * 30%
D1 = $1.80

Cost of Retained Earnings, Ke = D1 / P0 + g
Cost of Retained Earnings, Ke = $1.80 / $42.00 + 0.10
Cost of Retained Earnings, Ke = 0.1429 or 14.29%

Cost of New Common Stock, Kn = D1 / [P0 - F] + g
Cost of New Common Stock, Kn = $1.80 / [$42.00 - $3.50] + 0.10
Cost of New Common Stock, Kn = $1.80 / $38.50 + 0.10
Cost of New Common Stock, Kn = 0.1468 or 14.68%

Answer d.

D1 = D0 * (1 + g)
D1 = $4.00 * 1.05
D1 = $4.20

Cost of Retained Earnings, Ke = D1 / P0 + g
Cost of Retained Earnings, Ke = $4.20 / $68.00 + 0.05
Cost of Retained Earnings, Ke = 0.1118 or 11.18%

Cost of New Common Stock, Kn = D1 / [P0 - F] + g
Cost of New Common Stock, Kn = $4.20 / [$68.00 - $5.00] + 0.05
Cost of New Common Stock, Kn = $4.20 / $63.00 + 0.05
Cost of New Common Stock, Kn = 0.1167 or 11.67%