Question

“There are different approaches to the computation of cost of equity capital and there is no explicit cost of retained earnings” Critically comment.

Answer 1

The cost of equity is the return also known as rate of return, is the amount an enterprise pays to its equity investors.

• There are various approaches to compute cost of equity capital, these are -

1. Dividend price method - The cost of capital can only be determined by dividing dividend per share with market value per share. This cost indicates a clear relationship between share price and dividend price.

2. Earning price approach - The approach suggests that one should not co-relate market value per share with dividend per share, but must use total earnings and try to co-relate it with share market value.

• Compared to some finance elements, even equity shares or debt, businesses have to pay certain interest or dividend costs.
• There is a cost attached to it, business has to bear but one does not pay anything to anybody in retained earnings because it is the enterprise's own money