Question

If the IOP Corporation follows CAPM and the market and risk-free rate of return are 12 and 5 percent, respectively. Obtain the firm’s beta, assuming that the cost of equity capital is 13 percent. Round your final answer to two decimal places.

Answer 1

Solution:

Cost of equity capital as per Capital Asset Pricing Model is calculated using the following formula :

R_E = R_F + [ β * ( R_M - R_F ) ]

Where

R_E = Cost of equity capital   ; R_F = Risk free rate of return ; β = Beta of the stock ;              R_M = Market rate of return

As per the information given in the question we have

R_F = 5 %   ; R_M = 12 %   ;   R_E = 13 %   ; β = To find

Applying the above values in the formula we have

13 % = 5 % + [ β * ( 12 % - 5 % ) ]

13 % = 5 % + [ β * ( 7 % ) ]

13 % - 5 % = β * ( 7 % )

8 % = β * ( 7 % )

β = 8 / 7 = 1.1429

β = 1.14 ( when rounded off to two decimal places )

Thus the beta of IOP Corporation is = 1.14