Question

1) Ford motor company has a beta of 1.08. If the expected return on the market is 8.5%, and the risk free rate is 1.4%, what is the cost of equity capital according to the CAPM?

Please list answers to two decimal places (9.99%).

2) Your company has preferred stock currently selling for $79.93 on the New York Stock Exchange (NYSE). If the stock paid a dividend of $2.22 last year, what is the cost of preferred stock to your company?

Answer 1

Solution:

1) Ford Motor Company beta: 1.08

Expected Market return: 8.5%, and risk-free rate: 1.4%,

Hence, using CAPM Cost of equity capital: Risk-free rate + beta ( Market Return - Risk-free return)

Cost of equity capital: 0.014 + 1.08 ( 0.085 - 0.014)

Cost of equity capital: 0.014 + 0.0766

Cost of equity capital: 0.0906 or 9.06%

2) Preferred stock Price: $79.93

Dividend paid last year: $2.22

Cost of preferred stock: Dividend / Stock price

Cost of preferred stock: $2.22 / $ 79.93

Cost of preferred stock: 0.0278 or 2.78%

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