ABC Corp has the stock beta of 0.85. If the risk-free rate is 3% and the market risk premium is...

Question:

ABC Corp has the stock beta of 0.85. If the risk-free rate is 3% and the market risk premium is 10%, what is the cost of equity in the company?

a. 5.95%

b. 8.50%

c. 8.95%

d. 11.50%

e. 3.00%

Cost of Equity:

The cost of equity is a part of the total cost of the capital of a levered company. It is the opportunity cost lost due to having invested the capital raised from the equity in a specific investment. It is also the required return that investors expect from the company's equity investment which is determined after considering the stock beta and the risk premium.

Answer and Explanation:


Correct answer: Option d) 11.50%.

Explanation:

As per the data provided by ABC Corp:

  • Stock beta = 0.85
  • Risk-free rate, rf = 3%
  • Risk premium = 10%
  • Cost of equity, Ke =?

Computation:

As per the CAPM equation,

Ke = rf + (Beta * Risk premium)

Ke = 3% + (0.85 * 10%)

Ke = 11.50%


Learn more about this topic:

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Required Rate of Return (RRR): Formula & Calculation

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Chapter 1 / Lesson 31
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