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The Fraber Corporation's common stock has a beta of 0.6. If the risk-free rate is 1.7% and the...

Question:

The Fraber Corporation's common stock has a beta of 0.6.

If the risk-free rate is 1.7% and the expected return on the market is 10%, what is the company's cost of equity capital? (Do not round intermediate calculations. Enter answer as a percent rounded to 2 decimal places.)

Capital Asset Pricing Model (CAPM):

The capital asset pricing model (CAPM) is used to ascertain the rate of return required by shareholders of a firm for the equity financing. It takes into consideration the risk-free rate prevailing on the government securities, the beta coefficient for the firm and the market risk premium on the stock.

Answer and Explanation:

The calculated value of the company's required return is 6.68%.

The market risk premium is given by:

  • = Market return - risk-free rate
  • = 10% - 1.7%
  • = 8.3%

The required rate of return for the company as per the CAPM (Capital Asset Pricing Model) equation is given by:

  • = Risk-free rate + (beta * market risk premium)
  • {eq}= 1.7\% + (0.6 * 8.3\%) {/eq}
  • {eq}= 1.7\% + 4.98\% {/eq}
  • = 6.68%

Learn more about this topic:

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Capital Asset Pricing Model (CAPM): Definition, Formula, Advantages & Example

from Financial Accounting: Help and Review

Chapter 15 / Lesson 6
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