In: Finance
You’ve been monitoring Bletchley Park Corporation and have calculated the following information. The company has a debt to asset ratio of 57.45%, market beta of 1.26, unlevered beta of .82 (at a 40% marginal tax rate), and a cost of equity of 13.67%. The risk free rate is 1.8%. The risk premium due to financial risk is closest to?
Answer:
Given data: Debt to asset ratio = 57.45%
Market beta = 1.26
Unlevered bata = 0.82
Cost of equity = 13.67%
Risk free rate = 1.8%
Market risk Premium can be straight calculated by using Capital asset pricing model theory;
formula : Cost of equity = Risk free rate + Market beta * Market risk premium
13.67% = 1.8% + 1.26 * risk premium
0.1367 = 0.018 + 1.26 * risk premium
0.1187 = 1.26 * risk premium
Risk premium = 0.1187 / 1.26 = 0.094206 = 0.094 = 9.42%.
So market risk premium is 9.42%.