Question

**Your portfolio has provided you with returns of 26.3
percent, 19.8 percent, 4.6 percent, and 7.9 percent over the past
four years, respectively. What is the geometric average
return.**

**A. 8.06 percent**

**B. 9.27 percent**

**C. 10.25 percent**

**D. 11.71 percent**

**E. 14.31 percent**

____________

**The common stock of Detroit Engines has a beta of 1.34
and a standard deviation of 11.4 percent. The market rate of return
is 11.5 percent and the risk-free rate is 3 percent. What is the
firm’s cost of equity?**

**A. 10.05 percent**

**B. 12.98 percent**

**C. 14.39 percent**

**D. 15.50 percent**

**E. 15.67 percent**

Answer #1

**Solution to PART
1**

Geometric Average Return = [(1 + 0.2630) x (1 + 0.1980) x (1 +
0.0460) x (1 + 0.0790)]^{1/4} – 1

= (1.7077068) ^{1/4} – 1

= 1.14315027 – 1

= 0.14315027 or

= 14.31%

“Hence, Geometric Average Return would be E. 14.31 percent”

**Solution to PART
2**

As per Capital Asset Pricing Model [CAPM], The Cost of Equity is computed by using the following equation

Cost of Equity = Risk-free Rate + Beta[Market Rate of Return – Risk-free Rate]

= 3.00% + 1.34(11.50% - 3.00%)

= 3.00% + (1.34 x 8.50%)

= 3.00% + 11.39%

= 14.39%

“Hence, the Cost of Equity will be C. 14.39 percent“

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