Question 3 (2 points)

XYZ currently has common stock trading at $40 per share. XYZ just paid a dividend of $2.00 per share, which is expected to grow at a constant rate of 5%. XYZ's beta is 1.5, the risk-free rate is 2%, and the market return is expected to be 8%. The pre-tax yield on XYZ's bonds is 7%. XYZ's finance department believes that new stock would require a premium of 5% over their own bond yield. Flotation cost for issuing new stock is 10%.

Compute the cost of retained earnings using the capital asset pricing model (show your answer in percent, and to 2 decimal places. Example: 9.62%).

Question 3 options: