Question

Cost of​ equity: SML. Stan is expanding his business and will sell common stock for the needed funds. If the current​ risk-free rate is 4.0​% and the expected market return is 12.0​%, what is the cost of equity for Stan if the beta of the stock is a. 0.75​? b.  0.90​? c.  1.05​? d.  1.20​? a. What is the cost of equity for Stan if the beta of the stock is 0.75​? nothing​% ​ (Round to two decimal​ places.)

Answer 1

a.

The cost of equity is 10% if beta is 0.75

b.

The cost of equity is 11.20% if beta is 0.9

c.

The cost of equity is 12.40% if beta is 1.05

d.

The cost of equity is 13.60% if beta is 1.2

Step-by-step explanation:

The SML approach is used to calculate the required rate or return (r) which is the minimum return that the investors require to invest in a company's stock. This is also referred to as the cost of equity. The formula for required rate of return under SML is,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate
• rM is the return on Market

a.

r = 0.04 + 0.75 * (0.12 - 0.04)

r = 0.10 or 10%

b.

r = 0.04 + 0.9 * (0.12 - 0.04)

r = 0.112 or 11.20%

c.

r = 0.04 + 1.05 * (0.12 - 0.04)

r = 0.124 or 12.40%

d.

r = 0.04 + 1.2 * (0.12 - 0.04)

r = 0.136 or 13.60%