Question

Stan is expanding his business and will sell common stock for the needed funds. If the current​ risk-free rate is 3.7​% and the expected market return is 10.5​%, what is the cost of equity for Stan if the beta of the stock is

a) 0.79?

b) 0.85?

c) 1.05?

d) 1.15?

Answer 1

As per Capital Asset Pricing Model [CAPM], The cost of equity is calculated by using the following formula

Cost of Equity = Risk-free Rate + Beta(Market Return – Risk-free Rate)

(a)-The Cost of Equity if the Beta is 0.79

Cost of Equity = Risk-free Rate + Beta(Market Return – Risk-free Rate)

= 3.70% + 0.79(10.50% - 3.70%)

= 3.70% + (0.79 x 6.80%)

= 3.70% + 5.37%

= 9.07%

(b)-The Cost of Equity if the Beta is 0.85

Cost of Equity = Risk-free Rate + Beta(Market Return – Risk-free Rate)

= 3.70% + 0.85(10.50% - 3.70%)

= 3.70% + (0.85 x 6.80%)

= 3.70% + 5.78%

= 9.48%

(c)-The Cost of Equity if the Beta is 1.05

Cost of Equity = Risk-free Rate + Beta(Market Return – Risk-free Rate)

= 3.70% + 1.05(10.50% - 3.70%)

= 3.70% + (1.05 x 6.80%)

= 3.70% + 7.14%

= 10.84%

(d)-The Cost of Equity if the Beta is 1.15

Cost of Equity = Risk-free Rate + Beta(Market Return – Risk-free Rate)

= 3.70% + 1.15(10.50% - 3.70%)

= 3.70% + (1.15 x 6.80%)

= 3.70% + 7.82%

= 11.52%