Question

Suppose the domestic U.S. beta of IBM is 1.0, that is PIBM =1.0, and that the expected return on the U.S. market portfolio is Rus = 12 percent, and that the U.S. T-bill rate is 6 percent. If the world beta measure of IBM is Penuta = 0.80 then we can say That if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity capital would be 20% lower than if U.S. markets were segmented. That if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity capital would be 10% lower than if U.S. markets were segmented. That if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity capital would be one-third lower than if U.S. markets were segmented. O None of the above

Answer 1

Correct answer is B i.e That if the US Markets are fully integrated with the rest of the world, IBM's Cost of equity capital would be 10% lower than if US Market were segmented.

Working

As per Capital Assets Pricing Model (CAPM) = Rf + (Rm-Rf) * Beta

  Where , Rf = Risk free rate of Return

Rm = Market rate of Return

Cost of Equity capital of US Market ( Beta = 1.0)

Cost of Equity Capital = 6% + (12% - 6%) * 1

Cost of Capital = 12%

Cost of Equity capital integrated with the rest of the world ( Beta = 0.8)

Cost of Capital = 6% +(12%-6%) *0.8

Cost of Capital = 10.8%

Therefore, Cost of Capital would be 10% [(12-10.8) / 12]% lower than if the US Market were Segmented.