Question

CalMark is a privately held company, so there is no information about beta available. However, a company in the same business with a debt to equity ratio the same as that of CalMark is publicly traded and has a beta which is two times that of the market. If the risk free rate is 4%, and the market risk premium is 5%, what is the estimated cost of existing equity for CalMark

Answer 1

r - Calmark = 14%

Step-by-step explanation:

Based on the comparative company analysis and using the CAPM we can calculate the required rate of return for CalMark. The comparative company analysis means to use the companies similar to the subject company to assume various ratios and factor about the subject company.

The formula to calculate the cost of equity which is also known as the required rate of return (r) is,

r = rRF + Beta * rpM

Where,

• rRF is the risk free rate
• rpM is the market risk premium

The beta for market is always equal to 1. So a beta twice of the market will be 2.

r - Calmark = 4% + 2 * 5%

r - Calmark = 14%