Question

Foe Corporation has a beta of 1.4, the expected return on a market portfolio is 8.7% and the risk free rate is expected to be 3.7% (so the market risk premium is expected to be 5%). Using the Capital Asset Pricing Model (on page 293 in the textbook), what is Foe’s after tax cost of equity?

Answer 1

Cost of Equity as per CAPM Model

Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return – Risk-free Rate of Return)

As per the above question,

Risk-Free Rate of Return = 3.7%

Beta = 1.4

Market Rate of Return = 8.7%

so Cost of Equity = 3.7% + 1.4 * (8.7% - 3.7%)

= 3.7% + 1.4 * 5%

= 3.7% + 7%

=10.7%