-Roseanne can use the Dividend Growth Model and/or the Security Market Line (SML) approach to estimate the firm’s cost of retained earnings.
Dividend Growth Model Approach
RE = D1/Po + g
=(0.60*(1+.2078) /$25)+0.2078
= 0.23678 or 23.68%
SML Approach
RE = Rf + BE X [E(RM-Rf)]
=5% + 1.2(12% - 5%)
=13.4%
Note: The cost of equity does not have to be adjusted for taxes because the return earned by common stockholders is based on the firm’s net income, which is an after-tax item