Question

In: Finance

Cost of? equity: SML.??Stan is expanding his business and will sell common stock for the needed...

Cost of? equity: SML.??Stan is expanding his business and will sell common stock for the needed funds. If the current? risk-free rate is

6.36.3?%

and the expected market return is

13.713.7?%,

the cost of equity for Stan is

10.6710.67?%

if the beta of the stock is

0.590.59.

b.??

12.4412.44?%

if the beta of the stock is

0.830.83.

c.??

14.0714.07?%

if the beta of the stock is

1.051.05.

d.??

16.3616.36?%

if the beta of the stock is

1.361.36.

Suppose Stan had to delay the sale of the common stock for six months. When he finally did sell the? stock, the? risk-free rate had fallen to

5.35.3?%,

but the expected return on the market had risen to

14.714.7?%.

What was the effect on the cost of equity by waiting six? months, using the four different? betas? What do you notice about the increases in the cost of equity as beta? increases?

Solutions

Expert Solution

1) ROE has increased. Although, risk free rate is decreased, but market premium ( Market return - Risk free rate) has increased. Hence, ROE = Risk Free Rate + Beta x(Market Return - Risk Free) - ROE has increased. Compariosn is shown in below tables

2) ROE is postivile related with Beta. Hence, with the increase of beta, ROE will also increase.

Question	Risk Free Rate	Beta	Market Return	ROE = Risk Free Rate + Beta x(Market Return - Risk Free)
	6.3630%		13.7137%
a	6.3630%	0.59059	13.7137%	10.70%
b	6.3630%	0.83083	13.7137%	12.47%
c	6.3630%	1.05105	13.7137%	14.09%
d	6.3630%	1.36136	13.7137%	16.37%

After 6 Months
Question	Risk Free Rate	Beta	Market Return	ROE = Risk Free Rate + Beta x(Market Return - Risk Free)
	5.3530%		14.7140%
a	5.3530%	0.59059	14.7140%	10.88%
b	5.3530%	0.83083	14.7140%	13.13%
c	5.3530%	1.05105	14.7140%	15.19%
d	5.3530%	1.36136	14.7140%	18.10%

jeff jeffy answered 1 year ago

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