Final answer:
The cost of equity capital for a firm with a beta of 2 can be calculated using the Capital Asset Pricing Model (CAPM) by multiplying the risk-free rate by the beta and adding the equity risk premium. In this case, the cost of equity capital would be 4%.
Step-by-step explanation:
The cost of equity capital for a firm with a beta of 2 can be calculated using the Capital Asset Pricing Model (CAPM). CAPM is a widely used method to determine the required return on an investment based on its risk. It calculates the cost of equity by multiplying the risk-free rate (average 1-year T-bill rate) by the beta of the stock, and then adding the risk premium.
Given the information provided, the risk-free rate is 2 percent and the dividend growth rate is 10 percent. To calculate the cost of equity, we subtract the risk-free rate from the market dividend yield (average market dividend yield) to get the equity risk premium. Then, we multiply the equity risk premium by the beta of the stock and add the result to the risk-free rate.
In this case, the cost of equity capital for a firm with a beta of 2 would be: 2% + (3% - 2%) * 2 = 4%.