3. Why is there a cost associated with a firm’s retained earnings?
After a company makes money (earnings), the one that should owns that money is the shareholders. But when the company retain earnings, it is not giving the money to the shareholders, but keeping it and invest it. Well those shareholders want some return on that money that is keeping. How much return do they expect? They want the same amount as if they had gotten the retained earning in the form of dividends, and bought more stock in the company with them. That is the cost of retained earnings.