Question

The comparable company has a beta at 1.2 with D/A ratio being 0.2. D/A ratio of the target company is 0.5. Marginal tax rate is 40%. Rf is 8%. Expected market return is 20%. What is the cost of equity for the target company?

Answer 1

Cost of Equity (COE): $Rf + β [E(m) – R(f)]$

where,

$Rf =$ Risk-Free Rate of Return

β = Beta of the stock

$E(m) =$  Expected market return

$COE= 0.08 + 1.2 (0.2 - 0.08)\\COE = 0.224$