Question

Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin's equity beta is 0.86 the risk-free rate is 3.8 %and the market risk premium is5.4 % If your firm's project is all-equity financed, estimate its cost of capital.

Answer #1

Under the Capital Asset pricing model | ||||||

Rs = Rf + Beta*(Rm-Rf) | ||||||

Rf is the risk free rate that is .038. | ||||||

Beta = .86 | ||||||

(Rm - Rf) is the market risk premium that is .054. | ||||||

Rs is the expected return on the stock. | ||||||

Rs = .038 + (.86*.054) | ||||||

Rs = .038 + (.04644) | ||||||

Rs = .08444 | ||||||

The expected return on the stock is 8.44%. | ||||||

The expected return on the stock is the cost of equity. | ||||||

The cost of equity is 8.44%. | ||||||

Since the firm's project is all-equity financed, the cost of capital | ||||||

is equal to the cost of equity. | ||||||

The cost of capital is 8.44%. |

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