Question

Cost of​ equity: SML. Stan is expanding his business and will sell common stock for the needed funds. If the current​ risk-free rate is 6.5​% and the expected market return is 13.8​%, the cost of equity for Stan is

a. 11.68% ​if the beta of the stock is 0.71.

b. 13.36​% if the beta of the stock is 0.94.

c. 14.02​% if the beta of the stock is 1.03.

d. 15.77​% if the beta of the stock is 1.27.

Suppose Stan had to delay the sale of the common stock for six months. When he finally did sell the​ stock, the​ risk-free rate had fallen to 5.5​%, but the expected return on the market had risen to 14.8​%. What was the effect on the cost of equity by waiting six​ months, using the four different​ betas? What do you notice about the increases in the cost of equity as beta​ increases?

a. What is the new cost of equity if the beta of the stock is 0.71​?

​ (Round to two decimal​ places.)

b. What is the new cost of equity if the beta of the stock is 0.94​?

​ (Round to two decimal​ places.)

c. What is the new cost of equity if the beta of the stock is 1.03​?

​ (Round to two decimal​ places.)

d. What is the new cost of equity if the beta of the stock is 1.27​?

​ (Round to two decimal​ places.)

What do you notice about the change in the cost of equity as beta​ increases? ​(Select the best​ response.)

A. A beta of 0.71 results in an increase in the cost of equity of 0.42​% (12.10​%−11.68​%). A beta of 1.27 results in an increase in the cost of equity of 1.54​% ​(17.31​%−15.77​%). The cost of equity increases as beta increases.

B.A beta of 0.71 results in a decrease in the cost of equity of 0.42​% ​(12.10​%−11.68​%). A beta of 1.27 results in a decrease in the cost of equity of 1.54​% ​(17.31​%−15.77​%). The cost of equity decreases at an increasing rate as beta increases.

Answer 1