Rollins Corporation
Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock that pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. 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 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find rs. The firm's net income is expected to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent.
-Refer to Rollins Corporation.What is Rollins' cost of retained earnings using the bond-yield-plus-risk-premium approach?
A) 13.6%
B) 14.1%
C) 16.0%
D) 16.6%
E) 16.9%

Question

Quizplus · Accepted Answer

The cost of retained earnings using the bond-yield-plus-risk-premium approach can be calculated using the following formula:

rs = Rf + β(Rm - Rf) + RP

where,
Rf = Risk-free rate = 10%
β = Beta = 1.2
Rm = Market risk premium = 5%
RP = Risk premium = 4%
Therefore, rs = 10% + 1.2(5%) + 4% = 16%

Note: The cost of retained earnings is also known as the cost of equity.

Rollins Corporation Rollins Corporation Is Constructing Its MCC Schedule. Its Target Capital