Question

Wild Swings Inc.’s stock has a beta of 2.5. If the risk-free rate is 6% and the market risk premium is 7%, what is an estimate of Wild Swings’ cost of equity?

Answer 1

r = 0.235 or 23.5%

Step-by-step explanation:

Using the CAPM, we can calculate the required/expected rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * rpM

Where,

• rRF is the risk free rate

• rpM is the market return

r = 0.06 + 2.5 * 0.07

r = 0.235 or 23.5%