Question

A risk analyst gives Oracle Corp., the enterprise software and database management firm, a CAPM (Capital Asset Pricing Model) equity beta of 1.20. The risk-free rate is 4%. Required: Prepare a table with the cost of capital (cost of equity) that you would calculate for the equity with the following estimates of the market risk premium. (12 points) 4.5% 6.0 % 6.5% 7.0 %

8:17 LTE Luc & Mavis.docx Done Background - Supposed you are a manager of the Hotel Cristal and you need to manage the conflict of 2 employees from the Marketing department - Luc is 45 years old experience marketing in Hotel Cristal (who is very serious on work all the time) - Mavis is a young dynamic employee who has been working for many popular companies on marketing department - Mavis offered some of new marketing strategies to improve marketing line for Hotel - After Luc heard about that from his subordinate, he was very dissatisfied because the current marketing strategies used for the hotel are Luc's idea and he thinks it's the best! At the end of that day, Luc tried to discuss with Mavis about those strategies but suddenly became huge argument Dialogue Luc: Hey Mavis- may I talk with you for a while about your new marketing strategies? Mavis: Yes, sure please have a sit first Luc: Well... I heard that you would like to improve the marketing strategies for a hotel but in my opinion, I think it's better to keep the current one based on my experiences that I have been working here for many years. So, I know which one is fit for our hotel Mavis: Honestly, it might be good for last year or the last 2 years! But now I think it needs to change, it is not fit with our hotel marketing anymore, we have to improve it Luc: So, you mean mine is not good? you just work here, not even 1 year how can you know better than me? Mavis: No, I didn't mean your ideas are not good. But I have been working for many companies, II experience many situations as well. So, I think it's time to change something new! To be different from others Luc: But your previous job is not related to the Hotel at all! You are still lack of some skills in my sight. and if your strategies made the hotel goes down, how will you take responsibility

Answer 1

Solution:

We know that Ke ie. the cost of equity can be calculated using the CAPM model which states ….

Ke = Rf + beta* Market risk premium {Rm - Rf}

We have Rf= 4% , beta = 1.20

Cost of Equity

Sno	Market Risk Premium	Ke Calculation	Answer
1	4.5%	4% + 1.20 (4.5%)	9.4%
2	6%	4% + 1.20 (6%)	11.2%
3	6.5%	4% + 1.20 (6.5%)	11.8%
4	7%	4% + 1.20 (7%)	12.4%