2B4B THE MANAGEMENT OF OLD FENSKE COMPANY (OFC) HAS BEEN REVIEWING TH...

137.

CSO: 2B4b

LOS: 2B4b

The management of Old Fenske Company (OFC) has been reviewing the company’s

financing arrangements. The current financing mix is $750,000 of common stock,

$200,000 of preferred stock ($50 par) and $300,000 of debt. OFC currently pays a

common stock cash dividend of $2. The common stock sells for $38, and dividends have

been growing at about 10% per year. Debt currently provides a yield to maturity to the

investor of 12%, and preferred stock pays a dividend of 9% to yield 11%. Any new issue

of securities will have a flotation cost of approximately 3%. OFC has retained earnings

available for the equity requirement. The company’s effective income tax rate is 40%.

Based on this information, the cost of capital for retained earnings is

a.

9.5%.

b.

14.2%.

c.

15.8%.

d.

16.0%.