Question

The following financial statement data pertain to Southwater, Inc., a manufacturer of women's suits (dollar amounts in millions): Total Assets $154,287 Interest-Bearing Debt $33,984 Average Pre-tax borrowing cost 7.75% Common Equity: Book Value $21,365 Market Value $66,735 Income Tax Rate 39.6% Market Equity Beta 0.77 Market Premium 7.45% Risk-free interest rate 2.5% a) Calculate the company's cost of equity capital.

Answer 1

The cost of equity capital is 8.24%

Step-by-step explanation:

The cost of equity capital of a firm is the required rate of return on a firm's equity. In case of common equity, the required rate of return (r) can be calculated using the CAPM approach. The formula for required rate of return or cost of equity capital under this model is,

r = rRF + Beta * rpM

Where,

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

r = 0.025 + 0.77 * 0.0745

r = 0.082365 or 8.2365% rounded off to 8.24%