Question

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. the beta is 1.25, the yield on a 6-month treasury bill is 3.50%, and the yield on a 20-year treasury bond is 5.50%. the required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. the firm's tax rate is 40%. based on the capm, what is the firm's cost of equity?

Answer 1

Answer: 0.1525

Explanation:

Given the following :

Market average annual return(Rm) = 14.50% = 0.145

Required return on stock(Rf) = 11.50% = 0.115

Beta (B) = 1.25

Using the Capm, cost of equity(Ke) is given as :

Ke = Rf + B(Rm - Rf)

Ke = 0.115 + 1.25(0.145 - 0.115)

Ke = 0.115 + 1.25(0.03)

Ke = 0.115 + 0.0375

Ke = 0.1525