QUESTION 32 Suppose you are trying to estimate the cost of equity for a firm as
ID: 2769815 • Letter: Q
Question
QUESTION 32
Suppose you are trying to estimate the cost of equity for a firm as part of the calculation of the Weighted Average Cost of Capital (WACC). If the risk-free rate is 4.7%, the expected market risk premium is 5.3%, and the beta is 1.4 for this firm's equity, what would be the expected cost of equity for this firm using CAPM? (Answer to the nearest tenth of a percent, but do not use a percent sign).
QUESTION 33
Suppose you are trying to estimate the after tax cost of equity for a firm as part of the calculation of the Weighted Average Cost of Capital (WACC). If the risk-free rate is 4.5%, the expected market risk premium is 5.4%, the beta is 1.9 for this firm's equity, and the corporate tax rate is 39%, what would be the expected after tax cost of equity for this firm using CAPM? (Answer to the nearest tenth of a percent, but do not use a percent sign).
Explanation / Answer
E [ r e ] = E [ r f ] + ( E [ r m ] E [ r f ]) f
E[re] is the expected return on equity
E[rf] is the expected return on a risk-free asset
E[rm] is the expected rate of return for the market;
and, is a measure of the systematic riskiness of the asset.
( E [ r m ] E [ r f ]) is the market risk premium
1.
E [ r e ] = .047+1.4(.053)
=.1212 or 12.12 percent
2.
E [ r e ] = .045+1.9(.045)
=.1305
=13.05 percent