Assume that Kish Inc. hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $0.90; P0 = $30.00; and g = 7.00% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?
To calculate the cost of equity from retained earnings using the Dividend Discount Model (DCF) approach, we need to use the formula:
Cost of Equity (Ke) = (Dividends per Share (DPS) / Price per Share) + Growth Rate (g)
Let's plug in the given data to calculate the cost of equity from retained earnings:
D0 = $0.90 (dividends per share)
P0 = $30.00 (price per share)
g = 7.00% (growth rate)
Ke = ($0.90 / $30.00) + 0.07
First, we divide the dividends per share by the price per share:
DPS = $0.90 / $30.00 = 0.03
Next, we add the growth rate:
Ke = 0.03 + 0.07 = 0.10 or 10%
Therefore, the cost of equity from retained earnings is 10%.
Keep in mind that this calculation assumes that the growth rate is constant in perpetuity and that the D0 value represents the dividends paid in the most recent period.