Answer to Question #122743 in Finance for Reema

Question

Suppose our company has a beta of 1.5. The market risk premium is expected to be 9%, and the current risk-free rate is 6%.
•We have used analysts’ estimates to determine that the market believes our dividends will grow at 6% per year and our last dividend was $2.
•Our stock is currently selling for $15.65. What is our cost of equity?

Answer 1

There are two ways to compute the cost of equity:

Using Security Market Line (SML)

E(R_i) = R_f + β_i * [E(R_m) – R_f]

where

E(R_i) = Expected return on asset

R_f = Risk-free rate of return

β_i = Beta of asset

E(R_m) = Expected market return

$RE = 0.06 + 1.5(0.09)$

=19.5%

The cost is thus approximately 19.5%