Find the Cost of equity from the information below Historic Beta (computed over

Question

Find the Cost of equity from the information below Historic Beta (computed over last 10 years) Expected Long-Term Future Beta 1-year Treasury bill 10-year Treasury bond Last year's dividend Today's Stock Price Expected Long-Term Growth Rate in Earnings Historic Geometric Average Market Risk Premium (S&P; 500 return 10-year T-bond) Historic Geometric Average Market Risk Premium 1.6 1.4 1.00% 4.00% $1.00 $15.00 5.00% 4.50% (S&P; 500 return 1 year T-bill) Tax rate 7.10% 40.00% Cost of Equity

Explanation / Answer

Adjusted beta = 2/3 x Historical beta + 1/3 x future beta = 2/3 x 1.6 + 1/3 x 1.4 = 1.53

Using CAPM, Cost of equity = Rf + beta x MRP

in this case, Rf - Risk free rate = 4% and MRP - Market Risk Premium = 4.5%

=> Cost of equity = 4% + 1.53 x 4.5% = 10.90%

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