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?