"Corporate Finance":Cost of equity

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Questions 1:

A company that wants to determine its cost of equity gathers the following information:

Corporate Finance:Cost of equity

Using the capital asset pricing model (CAPM) approach, the cost of equity (%) for the company is closest to:

A 、12.6%.

B、 7.5%.

C 、13.1%.

Questions 2:

A company intends to issue new common stock with floatation costs of 5.0% per share. The expected dividend next year is $0.32, and the dividend growth rate is expected to be 10% in perpetuity. Assuming the shares are issued at a price of $14.69, the cost (%) of external equity for the firm is closest to:

A 、12.2.

B 、12.5.

C、 12.3.

View answer resolution

【Answer to question 1】C

【analysis】

C is correct. CAPM: Cost of equity = Risk-free rate + Beta × Market risk premium = 3.5% + 1.6 × (6.0%) = 13.1% The 10-year risk-free rate is appropriate based on the long-term duration of the cash flows from the project. B is incorrect. Deducting the risk-free rate from the market risk premium would lead to: 3.5% + 1.6 × (6.0% – 3.5%) = 7.5% A is incorrect. If the 90-day T-Bill rate is used as the risk-free rate, the answer will be: 3.0% + 1.6 × (6.0%) = 12.6%

【Answer to question 2】A

【analysis】

Corporate Finance:Cost of equity

A is incorrect because it does not include floatation costs.B is incorrect because it treats D1 as the current dividend making it equal $0.32 × (1 + 0.10) in the equation.

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