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

Answer:

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Answer 2

The cost of equity capital is the firm's return to the equity investor.

The different approaches to the cost of equity capital are -

1. Dividend price approach - According to the dividend price method, the cost of capital can be determined by comparing dividend per share with the market value per share. This expense indicates a strong relationship between equity stock prices and dividend rates.

2. Earnings approach - This strategy suggests we do not co-relate dividend per share with market value per share but we should use overall earnings and try to co-relate it with the market value of the stock.

3. Realized yield approach - This method is an improvement in the method to the dividend rates while measuring capital costs. Within this method the capital costs are calculated by reviewing past dividend payments.