Question

Alpha Inc.'s beta coefficient is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Based on the capital asset pricing model (CAPM), what should be Alpha's cost of retained earnings?

Answer 1

Answer:

Alpha's cost of retained earnings is 16%

Explanation:

Cost of retained earnings is approximated by the returns that investors expect from their equity in a company.

Capital asset pricing model describes the relationship that exists between expected returns on investment and the risk of the investment.

Returns on investment is equal to the sum of risk free returns and risk premium.

Returns expected= Risk free rate+ (Beta coefficient * Market risk premium)

Returns expected= 10+ (1.2* 5)

Returns expected= 16%

Find below an illustration of the Capital Asset Pricing Model.