A company is trying to determine it\'s cost of equity using the Fama-French mode

Question

A company is trying to determine it's cost of equity using the Fama-French model. Details are below.

The beta is 1.3.

The risk free rate is 2.00%.

The risk premium on the market is 5.50%.

The stock is expected to pay a dividend of $3.00 next year.

The stock is trading at $100 per share.

The return on equity is 12%.

The retention ratio is 80%.

The return for the Small sized portfolio minus the bid-sized portfolio is 3.00%.

The slope coefficient is .3.

The high book to market portfolio minus the low book to market value portfolio is -2.00%.

The factor weighting (slope) is .4.

Explanation / Answer

expected return = risk-free rate + beta * (market risk premium)+slope coefficient*return for the Small sized portfolio minus the bid-sized portfolio+factor weighting*high book to market portfolio minus the low book to market value portfolio

=2+1.3*5+0.3*3+0.4*(-2) = 8.6%

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