Reference no: EM132518558

Point 1: Rollins Corporation has a target capital structure consisting of 20% debt, 20% preferred stock, and 60% common equity. Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. It has 20-year, 12% semiannual coupon bonds that sell at their par value of $1,000. The firm could sell, at par, $100 preferred stock that pays a 12% annual dividend, but flotation costs of 5% would be incurred. Rollins' beta is 1.2, the risk-free rate is 10%, and the market risk premium is 5%. Rollins is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%. The firm's policy is to use a risk premium of 4% when using the bond-yield-plus-risk-premium method to find rs. Flotation costs on new common stock total 10%, and the firm's marginal tax rate is 40%.

Question 1: What is the firm's cost of retained earnings using the DCF approach?

a. 13.6%

b. 14.1%

c. 16.0%