Question

Radical VenOil, Inc. has a cost of equity capital equal to 22.8 percent. If the risk-free rate of return is 10 percent and the expected return on the market is 18 percent, then what is the firm's beta if the marginal tax rate is 35 percent?

A) 1.0
B) 1.28
C) 1.60
D) 4.10

Answer 1

Using the Capital Asset Pricing Model (CAPM), Radical VenOil, Inc.'s beta is calculated to be 1.6 when the cost of equity is 22.8%, risk-free rate is 10%, and market return is 18%. This corresponds to answer option C.

Step-by-step explanation:

Radical VenOil, Inc.'s beta can be calculated using the Capital Asset Pricing Model (CAPM). The CAPM formula is:

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

Plugging the given values into the formula:

22.8% = 10% + Beta * (18% - 10%)

First, subtract the risk-free rate from both sides:

12.8% = Beta * 8%

Next, divide both sides by the market premium (8%):

Beta = 12.8% / 8%

Beta = 1.6

The firm's beta is therefore 1.6, which aligns with option C.