What is cost of retained earnings formula?

The profits earned by a company are mainly divided into two parts:

• Dividend, and
• Retained Earnings

The part of profit distributed to its shareholders is called a dividend. The part of the profit that the company holds for future expansion or diversification plans is called retained earnings.

As the name suggests, retained earnings are the profit that is retained in the company. Retained earnings can be used for various purposes:

• To distribute as dividends to shareholders
• Expansion of business
• Diversification
• For an expected merger or acquisition

As the profits of the company belong to shareholders, retained earnings are considered as profits re-invested in the company by the shareholders.

The formula to calculate the cost of retained earnings is:

(Expected dividend per share / Net proceeds) + growth rate

• Expected dividend is the dividend an investor expects for his investment in the company’s shares based on the last year’s dividend, trends in the markets, and financial statements presented by the company.
• Net proceeds is the market value of a share, that is, how much an investor would get if he sells his shares today.
• Growth rate represents growth of company’s revenue, dividend from previous years in the form of a percentage.

The expected dividend per share is divided by net proceeds or the current selling price of the share, to find out the market value of retained earnings.

The growth rate is then added to the formula. It’s the rate at which the dividend grows in the company.

For example:

The net proceeds from share is Rs 100, expected dividend growth rate is 2% and expected dividend is 5.

Cost of retained earnings

= (Expected dividend per share / Net proceeds) + Growth rate

= (5 / 100) + 0.02

= 0.07 or 7%