Question

Blackstone Technology is planning to invest in some project using external equity. The company has a beta of 1.1. The return on the market is expected to be 14% while the risk free rate is expected to be 3%. If flotation costs are 4%, then what is the cost of equity

Answer 1

Answer:

Cost of equity = 19.1 %

Explanation:

Cost of equity = required rate of return + flotation cost

The Capital assets pricing model would be used to determined  the required rate of return

The capital asset pricing model (CAPM): relates the price of a share to the market risk or systematic risk. The systematic risk is that which affects all the all the economic agents, e.g inflation, interest rate e.t.c  

Using the CAPM , the required rate of return is given as follows:  

E(r)= Rf +β(Rm-Rf)  

E(r) - required return

β- Beta

Rm- Return on market

Rf- Risk-free rate

DATA

E(r) =? , Rf- 3%, Rm-14% , β- 1.1, flotation cost - 4%

E(r) = 3% + 1.1× (14% - 3%) = 15.1 %

Cost of equity = required rate of return + flotation cost

                        = 15.1 % + 4% = 19.1 %

Cost of equity = 19.1 %