Question

# You have the following assets available to you: Asset Expected Return Riskless debt 3.8% Portfolio of...

You have the following assets available to you:

 Asset Expected Return Riskless debt 3.8% Portfolio of small cap stocks 9.0% Portfolio of large cap stocks 7.3% Portfolio of growth stocks 13.3% Portfolio of value stocks 8.8% S&P500 index fund 9.9%

What is the cost of equity for a firm with a market beta of 3.4, a SMB beta of 1.9, and a HML beta of 2.4? You may assume this firm has an alpha of zero. Please give your answers to four decimal places - an answer of 9.54% would be represented as 0.0954.

Assuming Alpha as zero, the cost of Equity is calculated using the following equation of Fama-French model three factor model

Cost of Equity

Where, rf is risk free rate

is Beta or factor coefficients

rm is market return

SMB is size premium (Small minus Big)

HML is value premium (High minus low)

Cost of Equity = 0.038 + 3.4*(0.099-0.038) + 1.9*(0.09-0.073) + 2.4*(0.088-0.133)

= 0.038 + 0.2074 + 0.0323 - 0.108

= 0.1697