What is added to the cost of retained earnings to account for flotation costs?

The flotation cost adjustment is the correct addition to the cost of retained earnings to account for flotation costs. Flotation costs represent the expenses incurred when a company issues new securities, including underwriting fees, legal expenses, and registration fees. These costs can significantly impact the overall cost of raising capital.

When companies retain earnings for reinvestment, they typically do not incur flotation costs because they are not issuing new stock. However, if new equity is being issued, it becomes essential to consider flotation costs in the overall assessment of the cost of capital. By adding the flotation cost adjustment to the cost of retained earnings, companies can ensure they are accurately reflecting the total cost of equity financing when making decisions about capital structure and investment strategies.

In contrast, the cost of debt typically pertains to the interest that needs to be paid on borrowed funds, which is unrelated to flotation costs. The market risk premium is a component used in determining the expected return on equity based on market risk, but it does not relate directly to flotation costs. Finally, accounting for tax liability usually involves considerations for the after-tax cost of debt but is not pertinent when discussing flotation adjustments for retained earnings.