Estimate the cost of capital for each firm


Problem: Companies A and B have the same business risks and are both solely financed by equity. The retention ratio for A is 60%, while that for B is 40%. The firms are identical in all other respects, and share the following characteristics:

· current earnings                          £373,000
· depreciation                                £100,000
· number of shares                        1 million
· rate of return on reinvested funds    21%
· share price cum div                      £2.15

Estimate the cost of capital for each firm. Which company will generate more shareholder value?

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Managerial Economics: Estimate the cost of capital for each firm
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