This preview shows page 1. Sign up to view the full content.
Unformatted text preview: rs may gain control of firm. Component cost of equity
Component cost of equity WACC = wdkd(1T) + wpkp + wcks ks is the marginal cost of common equity using retained earnings (using new equity).
The rate of return investors require on the firm’s common equity using new equity is ke. Cost of equity
Cost of equity Using retained earnings: ks
Issuing new common stock to raise capital: ks(SEO) Why is there a cost for retained Why is there a cost for retained earnings? Earnings can be reinvested or paid out as dividends.
Investors could buy other securities, earn a return.
If earnings are retained, there is an opportunity cost (the return that stockholders could earn on alternative investments of equal risk). Investors could buy similar stocks and earn ks.
Firm could repurchase its own stock and earn ks.
Therefore, ks is the cost of retained earnings. Two ways to determine the cost Two ways to determine the cost of common equity, ks The Dividend Growth Model
DGM: ks = (D1 / P0 )+ g
View Full Document
- Winter '14