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Cost of Retained Earnings Formula:
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The cost of retained earnings represents the opportunity cost of reinvesting profits back into the company rather than distributing them to shareholders as dividends. It's essentially the return shareholders expect to earn on their investment in the company.
The calculator uses the following formula:
Where:
Explanation: The formula combines the dividend yield (Dividends/Price) with the expected growth rate to determine the total expected return, which represents the cost of retained earnings.
Details: Understanding the cost of retained earnings helps companies make informed decisions about whether to reinvest profits or distribute them to shareholders. It's a key component in determining a company's weighted average cost of capital (WACC).
Tips: Enter the expected dividends per share in dollars, current market price per share in dollars, and expected growth rate as a percentage. All values must be positive numbers.
Q1: Why is there a cost to retained earnings?
A: Retained earnings have an opportunity cost because shareholders could have invested the money elsewhere if it had been distributed as dividends.
Q2: How is this different from cost of equity?
A: The cost of retained earnings is essentially the same as the cost of equity, since both represent the return expected by shareholders.
Q3: What if a company doesn't pay dividends?
A: For companies that don't pay dividends, alternative methods like the Capital Asset Pricing Model (CAPM) may be used to estimate the cost of equity.
Q4: How accurate is this calculation?
A: This provides an estimate based on current expectations. Actual returns may differ based on company performance and market conditions.
Q5: Should growth rate be historical or projected?
A: For forward-looking decisions, use projected growth rates rather than historical averages.