4. The cost of retained earnings

If a firm cannot invest retained earnings to earn a rate of return (LESS THAN or GREATER THAN OR EQUAL TO) the required rate of return on retained earnings, it should return those funds to its stockholders.

The current risk-free rate of return is 3.80% and the current market risk premium is 6.10%. Blue Hamster Manufacturing Inc. has a beta of 0.87. Using the Capital Asset Pricing Model (CAPM) approach, Blue Hamsters cost of equity is (9.57%, 10.02%, 11.84%, OR 9.11%).

Fuzzy Button Clothing Company is closely held and, as a result, cannot generate reliable inputs for the CAPM approach. Fuzzy Buttons bonds yield 11.50%, and the firms analysts estimate that the firms risk premium on its stock relative to its bonds is 3.00%. Using the bond-yield-plus-risk-premium approach, the firms cost of equity is (13.77%, 14.50%, 18.13%, OR 15.95%).

The stock of Cute Camel Woodcraft Company is currently selling for $32.45, and the firm expects its dividend to be $2.35 in one year. Analysts project the firms growth rate to be constant at 7.20%. Using the discounted cash flow (DCF) approach, Cute Camels cost of equity is estimated to be (13.72%, 15.16%, 19.49%, OR 14.44%).