Question
Use the following information to answer this question. Company Y has the following information on its balance sheet: Assets Liabilities Cash 1,000,000 Accounts Payable 1,000,000
Use the following information to answer this question.
Company Y has the following information on its balance sheet:
Assets | Liabilities | ||
Cash | 1,000,000 | Accounts Payable | 1,000,000 |
Accounts Receivable | 1,000,000 | Notes Payable | 1,250,000 |
Inventory | 750,000 | Current Liabilities | 2,250,000 |
Current Assets | 2,750,000 | Bond | 2,500,000 |
Preferred Stock | 1,250,000 | ||
Net Fixed Assets | 8,250,000 | Common Stock and Retained Earnings | 5,000,000 |
Total Assets | 11,000,000 | Total Liabilities + Equity | 11,000,000 |
In order to remain an industry leader, Company Y will need to raise $1.5 million to buy a new computer system. Its current operations are expected to add $500,000 to retained earnings during the coming year. Its outstanding bond is currently valued at par, has a 7% coupon rate, pays interest semiannually, and will mature in 6 years. The common stock is selling in the market at $38 per share, and has 145,000 shares outstanding. The company just paid an annual common stock dividend of $2.00 per share. The dividends are expected to grow at a constant rate of 5% per year. The current preferred stock (12,500 shares outstanding), carries an annual dividend of $4.00 per share and is selling in the market for 67.50 per share. The corporate tax rate is 30%.
Company Y can sell new common stock at current market price with a flotation cost of 4%, new preferred stock with an annual dividend of $4.00 per share to sell at $40 per share, and new semiannual coupon bonds with a par value of $1,000 with a 20 year maturity and a 9% coupon, to sell at 97.5% of par.
What is the after-tax cost of retained earnings?
| A. | 11.22% |
| B. | 10.26% |
| C. | 10.80% |
| D. | 10.53% |
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