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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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