Blue and Gray Corp. has the following capital structure: (10 points)

security beta total market value

senior debt 0.00 200

preferred stock 0.50 50

common stock 1.10 100 Blue and Gray is considering scaling up the operation without changing the nature of operation. In order to calculate the NPV, what discount rate should Blue and Gray use? Assume any new investment is all equity financed, the risk-free rate is 3% and expected return on the market is 12%.

Select one:

1. 6.5%

2. 8.1%

3. 7.3%

4. 8.6%

5. 6.9%