Cost of Retained Earnings

It is usual practice followed by corporate managements to pay only a part of the profits after tax as cash dividend and to retain the remaining part in the business as surplus or reserves. In this way, retained earnings accumulate over the years and thus built up reserves of the company. The funds so accumulated over a period of time, virtually belong to the equity shareholders, to which they have a residual claim in the event of the winding up of the company.
Weston and Brigham have stated in their book – Essentials of Managerial Finance that “The cost of retained earnings or the return that must be earned on investments financed by retained earnings, is equal to the rate of return that investors expect to receive on stock.”