Question

Netflix common stock has a​ beta=0.6.

The​ risk-free rate is 9%​,

and the market return is 14​%.

a.  Determine the risk premium on Netflix common stock.

b.  Determine the required return that Netflix common stock should provide.

c.  Determine​ Netflix's cost of common stock equity using the CAPM.

Answer 1

Information provided:

Beta= 0.6

Risk free rate= 9%

Market return= 14%

a.Risk premium= Market return - Risk free rate

                              = 14% - 9%

                              = 5%

b. The required return on Netflix common stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke=Rf+b[E(Rm)-Rf]

where:

Rf=risk-free rate of return which is the yield on default free debt like treasury notes

Rm=expected rate of return on the market.

Rm-Rf= Market risk premium

b= Stock’s beta

Ke= 9% + 0.6*5%

     = 9% + 3%

     = 12%

c.The cost of common equity is also 12% computed using the capital asset pricing model

In case of any query, kindly comment on the solution.