Why is the cost of new common stock  (kn) higher than the cost of
retained earnings (Ke)?

Hi!!


Flotation Cost Definition:
"The costs associated with the issuance of new securities. 
Flotation costs include both the underwriting spread and the costs
incurred by the issuing company from the offering. Expressed as a
portion of gross proceeds, costs generally increase as risks
associated with the issue increase, or the size of the offering
decreases."
http://www.investopedia.com/terms/f/flotationcost.asp


The existence of flotation costs on new common stock is the only
difference between the cost of retained earnings and the cost of new
common stock.

See the formulas:
Cost of New Common Stock = g + Div_0 / P_0*(1-Fc) 
Cost of Retained Earnings = g + Div_0 / P_0

Where:
Div_0 = the first year dividend
P_0 = current market price
g = growth rate of dividend
Fc = flotation cost

Since Div_0/P_0 term in the cost of new common stock formula is
divided by a number between 0 and 1 the result is a higher number,
this lead us to the following conclusion:
The Cost of New Common Stock is the same as the cost of retained
earnings except it is higher due to flotation costs.


Hope that this helps you. Feel free to request for a clarification if you need it.

Regards.
livioflores-ga