Question

Assume these market averages: dividend growth rate = 10 percent; average market dividend yield = 3 percent; average 1-year T-bill rate = 2 percent. What is the cost of equity capital for a firm with a beta of 2?

Answer 1

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Answer 2

The cost of equity capital for a firm with a beta of 2 is calculated using the CAPM formula to be 24 percent, considering the given dividend yield, dividend growth rate, and risk-free rate.

Step-by-step explanation:

Cost of Equity Capital Calculation

The cost of equity capital for a firm with a beta of 2 can be calculated using the Capital Asset Pricing Model (CAPM), which is represented by the formula: Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Given the average market dividend yield is 3 percent, and the average 1-year T-bill rate (which we can use as the risk-free rate) is 2 percent, we can estimate the market return using the dividend yield and the dividend growth rate. Adding the dividend yield (3%) and the dividend growth rate (10%) gives us an estimated market return of 13%. Using the CAPM formula, we calculate the cost of equity as follows: 2% + 2 * (13% - 2%) = 2% + 2 * 11% = 2% + 22% = 24%.

Therefore, the cost of equity capital for the firm with a beta of 2 is 24 percent.