CA Inter P6 · Chapter 4 · Question 6 of 10
The market price of an equity share is ₹ 60, the expected dividend next year (D1) is ₹ 3 and dividends are expected to grow at 7% per annum. A fresh issue of equity would involve flotation costs of 5% of the market price. The cost of retained earnings, ignoring personal taxes, is:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) 12.00%
Explanation
Retained earnings involve no flotation cost, so Kr = D1/P0 + g = 3/60 + 0.07 = 0.05 + 0.07 = 12.00%. The figure 12.26% is the cost of new equity, which uses net proceeds of ₹ 57 (60 x 0.95). The figure 5% is only the dividend yield.
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